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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: ild who wrote (29491)	3/28/2005 10:32:30 AM
From: ild	Read Replies (2) \| Respond to of 110194

Berson's Weekly Commentary Economic Commentary March 28, 2005 How quickly will the Federal Reserve tighten monetary policy? Clear signs of sustained above-trend economic activity and ongoing increases in core inflation (growth rate in the core consumer price index (CPI) has doubled in the past 14 months, while that for the broader core chain-price index for personal consumption expenditures has risen by two-thirds over the past 16 months) caused the Federal Open Market Committee (FOMC -- the policy making arm of the Federal Reserve Board) to make some small but significant changes in the wording of its statement after its March 22nd meeting. Although the FOMC kept the phrase "measured pace" when describing how it would tighten monetary policy, it explicitly mentioned solid economic growth and increases in inflation and pricing power. In addition, the FOMC stated that sustainable economic growth and price stability could be achieved only with appropriate monetary policy action. Financial markets took these changes in the FOMC's post-meeting statement to mean that the Fed was prepared to tighten more quickly than the markets had previously assumed, especially if economic growth remained strong and core inflation continued to edge upward. Previously, financial markets had expected a year-end federal funds rate of 3.75 percent, with no tightenings larger than 25 basis points (according to futures prices from the Chicago Board of Trade). Today, markets are looking for the federal funds rate to climb to at least 4.00 percent by the end of 2005 (with a 20 percent chance of a 4.25 percent rate). Moreover, the chances of a 50 basis point increase in the federal funds rate at the June 29-30th FOMC meeting has risen to nearly 50 percent. The table below shows the market's expectations for the federal funds rate after each of the remaining 2005 FOMC meetings. Market Expectations for Fed Policy FOMC Meeting Date Expected Federal Funds Rate Next Most Likely Rate (Odds) May 3 3.00% 3.25% (20 percent) June 30 3.25% 3.50% (44 percent) August 9 3.50% 3.75% (16 percent) September 20 3.75% 4.00% (24 percent) November 1 4.00% 3.75% (16 percent) December 13 4.00% 4.25% (20 percent) With the federal funds rate currently at 2.75 percent, the CBOT figures suggest that the Federal Reserve will tighten by an additional 125-150 basis points over the remainder of 2005. From the low point in rates at the end of June last year, the federal funds rate would have increased by a total of 300-325 basis points over the 18 months ending at the close of this year. In the last tightening cycle, the Fed raised the federal funds rate by 175 basis points over a nearly 11 month period in 1999-2000 -- a much smaller move than in the current period. In the 1994-95 tightening cycle, however, the Fed increased the federal funds rate by 300 basis points over 12 months -- essentially the same rise in rates, but over a much shorter time period. Of course, the 4.00-4.25 percent federal funds rate expected by the end of 2005 may not be the peak -- if economic activity remains above-trend and (especially) if core inflation continues to move upward, then the Fed could tighten further in 2006. Even long-term interest rates were affected by the FOMC's wording change, with yields on 10-year Treasury notes rising to around 4.60 percent -- the highest level since last July. It was the change in expectations of future Fed policy and not the actual 25 basis point increase in the federal funds rate on March 22nd that caused the move in long-term rates, as a year-end federal funds rate of 3.75 percent was already incorporated into long-term bond yields. The 25-50 basis point increase in market expectations for the federal funds rate by year-end was new information for the bond market, and thus not already in long-term rates. Should expectations of Fed tightening move even higher, long-term rates could move upward still more. Even with this rise in long-term rates, and likely additional increases over the remainder of the year, the yield curve should flatten still more -- the typical pattern in a rate-tightening environment. This will be a very busy week for economic indicators, with the key employment report and ISM survey. On Tuesday, the Conference Board's estimate of consumer confidence is expected to edge down to 103.0 for March -- mostly because of higher oil prices. On Wednesday, the final revision to fourth quarter real GDP growth should bring it up to around 4.0 percent (annualized rate) -- bringing growth for all of 2004 also up to nearly 4.0 percent. On Thursday, personal income and expenditures for February are projected to rise by 0.3 and 0.6 percent, respectively. Overall consumer spending is slowing in the first quarter, but it remains reasonably strong. Also on Thursday, new orders for factory goods should rise by about 0.7 percent in February -- based on the already-known rise in durable goods orders. Core capital goods orders, however, are expected to be down sharply -- after several months of outsized gains. Additionally on Thursday, the Chicago Purchasing Managers Association survey is expected to show a modest rise to 63.0 for March -- showing slightly better industrial conditions in that region. Finally on Thursday, initial unemployment claims are projected to slip to around 320,000 for the week ending March 26th -- continuing to show strength. On Friday, nonfarm payroll employment for March is projected to rise by 240,000, with the unemployment rate down to 5.3 percent, the private workweek unchanged at 33.7 hours, and average hourly earnings up by 0.3 percent. While not a barn-burner, these data are indicative of a moderately strong labor market. Also on Friday, construction spending is expected to increase by 0.8 percent in February -- with broad-based strength in most sectors. Additionally on Friday, the Institute for Supply Management's (ISM) manufacturing survey index for March should edge up to around 56.0 -- the first increase in four months. In addition on Friday, the University of Michigan's final estimate for March consumer sentiment should be little changed from its mid-month figure of 92.9 -- with higher oil prices continuing to weigh on consumers. Finally, on Friday, domestic vehicle sales for March are projected to climb to around 13.1 million units (annualized pace) -- the strongest figure in three months. The auto market has finally recovered from a surge in sales during December. David W. Berson Fannie Mae Economics Last Revised: March 28, 2005 fanniemae.com