FED TALK Message Board - Msg: 17427678

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To: Jeff Jordan who started this subject	5/6/2002 9:02:22 AM
From: Jeff Jordan	of 94

Fed Brief Fed funds rate chart: briefing.com Updated: 06-May-02 Fed is Patient The Fed policy outlook makes for dull reading at turning points in the policy cycle. The waiting period over the last three swings from easing to tightening averaged over a year. With policy rates very accommodative at 40 year lows the wait will be shorter than average but don't be fooled. The Fed sees no need to rush the tightening cycle. That willingness to wait is clear from Fed comments and the March policy statement itself. The Fed has always proved willing to wait for the labor market in past turns to tightening. The current economy may leave the policymakers waiting for business investment as well. No Hurry The clearest indication of the Fed's desire to hold off any tightening came with the March policy announcement. The statement made a distinction between and expanding economy (GDP) and final demand (GDP ex-inventories) as it intended to head off pressure to tighten under expectation of a strong inventory-heavy rise in Q1 GDP. The bond vigilantes have shown their power in the past given the link between growth and long term yields. Higher long term borrowing rates would slow the upturn as the Fed used the opportunity to warn of it caution regarding broad-based growth rather than a post-recession spike from inventories. The timing of the Q1 GDP report just a week before the May FOMC meeting left the warning for on-hold policy. The Fed is waiting for the return of the business sector before taking their heavy foot off the accelerator. It was the plunge in business investment (on capital and labor) which brought on the recession and until investment contributes to growth it remains a risk. Unfortunately, the upturn in business investment waits for improvement in profits and heightened capacity use. The move in profits may not be far away as a Q4 upturn was disguised by the new tax laws (i.e. economic stimulus package). Thank very heavy cost-cutting, low input costs and strong productivity growth. Increased capacity use waits for demand to feed in to production, helped greatly by lean inventory supply. The labor market has always been the key policy indicator in the past. The Fed has always waited for the unemployment rate to begin a downward trend before stepping on the brakes in the past. The Jan and Feb declines heightened policy uncertainty as the March rise to 5.7% stole the market's weakened expectation for a May tightening. The rise in energy prices has turned the focus back on inflation. But oil prices simply do not tell the story of overall price pressures. PPI and its pipeline measures all show deflation from a year ago as the -2.6% annual decline from a year ago is the largest decline since the 1950s. Consumer prices, given the addition of service costs, are at the lowest annual growth rate since the 1960s as corporate America has been unable to lift prices and stay competitive. Simply put, inflation is not the element driving the timing of the tightening. Its economic growth. Timing Just when the Fed feels content taking back some of the post-9/11 emergency ease is unclear. Voting Dallas Fed president McTeer sounded what I would call the long end of the range by stating that a 5% unemployment rate (now 5.7%) and 77% capacity use (at 74.8%) is in line with the start of pre-emptive tightening. The FOMC was looking for a 6%-6 1/4% unemployment rate in 2002 just a few months ago. The May 7 FOMC meeting is the short end of the range but as unlikely as McTeer's call. Market expectations for the timing and speed of the eventual tightening are best presented by the policy rates embedded in the federal funds futures contract prices. Even the nearest term rates don't provide a reliable guide until just days before the FOMC meeting as the aggressive tightening priced in to the longer contract pricing has been easing off slightly. The chart below reflects a 25% probability for a tightening at the May 7 FOMC meeting and full expectation for a 25 bp tightening at the June 25-26 meeting. The market outlook sees a steady flow of policy tightenings after the go ahead is given. The average monthly rise over the second half of the year is 23 bps which leaves a 3.25% policy rate in December -- aggressive given current Fedspeak.

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