ANALYSIS: 3RD RATE HIKE COMING BUT 'CLOSE CALL' AT OCT 5 FOMC
By Steven K. Beckner
marketnews.com
Market News International (MktNews) - Whether to leave monetary policy unchanged or to take another precautionary credit tightening step will be a much closer call at Tuesday's meeting of the Federal Reserve's policymaking Federal Open Market Committee than many seem to think.
There is a strong case to be made for raising the federal funds rate for a third time. Indeed, it is almost inevitable at some point.
Some FOMC members will argue that the time to make that third move -- and thereby return the funds rate to its pre-Russia default level of 5.5% -- is now, Oct. 5.
All the traditional motives for tightening -- if withdrawing last fall's emergency liquidity can be called that -- are there. Domestic demand continues to grow above trend; foreign demand is reviving; financial market conditions remain supportive of growth; labor markets are tight; materials prices and medical costs are climbing and wage gains, while not yet clearly accelerating, have certainly stopped decelerating.
"Special factors" that have fortuitously restrained inflation in recent years are now working in the other direction, and it's only a matter of time until labor compensation growth catches up with productivity growth, and productivity growth could flatten out or slow, it will be further argued.
Augmenting the case for tightening, hawks can point to the National Association of Purchasing Management's index of industrial activity, which rose far more than expected in September, boosted by another upsurge in prices paid and by a big jump in new orders.
"Why wait" to raise rates? some Fed presidents and governors will ask. Particularly with Y2K problems apt to make it more difficult to raise rates later in the year?
Some are also apt to warn of the consequences of postponing a third rate hike that is all but inevitable. What kind of signal would delay send to the financial markets, particularly a stock market that has been helping fuel "excess demand?" If action is deferred, it will be argued, eventual tightening may have to be more aggressive.
It is not inconceivable such arguments will prevail at Tuesday's FOMC meeting. The Fed would then have demonstrated its determination to preempt inflation, removed rate hike uncertainties for the next several months and contributed to a dampening of demand and asset prices without undermining expansion. Indeed, arguably, another timely move would be the best thing the Fed could do to sustain the expansion.
However, it is not clear an FOMC consensus can be found to raise rates again this week.
The counter-argument, essentially, is that there is no compelling reason to act right now. Yes, demand (and real growth) are stronger than our conventional notions of potential. And yes, unemployment is lower than our traditional concepts of the nonaccelerating inflation rate. But what's new?
Where's the "overheating?" Where's the inflation? Where is the wage acceleration? Where is the business pricing power?
Those who wish to stand pat can reason that the Fed has already taken two preemptive steps on traditional grounds without evidence of actual inflation despite grave uncertainties about the ability of its traditional models to forecast inflation in a new productivity climate. Why not watch and wait for awhile to see how some of those uncertainties resolve themselves? In short, why not wait for some indication of actual price pressures?
And anyway, the stock market is well off its highs, the dollar has firmed, fiscal policy is tight ... . What's the hurry?
Another counter-argument that can be made is that there is nothing to prevent the Fed from acting at its November or even December FOMC meetings if need be, despite widespread speculation that Y2K considerations make Oct. 5 the FOMC's last "window of opportunity."
The feeling is that the Fed has taken enormous precautions to provide liquidity and insure the smooth functioning of the payments system and that the economic impact of Y2K is apt to be minimal. Therefore, the Fed has the flexibility to wait for more data and, if justified, make that third move at the November 16 FOMC meeting.
The debate is sure to be lively, and while the odds probably favor the Fed staying on hold, the odds do not weigh all that heavily against further tightening. |
