FOMC Worries Mainly About Rising Federal Deficits And Higher Inflation

Tuesday, October 11, 2005

Ongoing lax fiscal policy and growing inflationary pressures seem to be the two main worries in the economic outlook of the Federal Open Market Committee (FOMC), the latest FOMC minutes show. While hurricanes Katrina and Rita had added to to the uncertainty about the course of the economy over the coming months - but were seen to have a temporary negative effect only - the committee decided to stay on its path of 25 basis point Fed Funds rate hikes in order to quell any misled expectations about "its perceptions of the fundamental strength and resilience of the economy and about its commitment to fostering price stability."
Expect further rate hikes and do not assume that the Fed will stop at 4.50 %. The FOMC acknowledged that even after the latest rate hike,
"the federal funds rate would likely be below the level that would be necessary to contain inflationary pressures, and further rate increases probably would be required."
A bit further down the statement had some milder words.
"Although energy prices had the potential to add to inflation pressures, and inflation expectations had recently exhibited some signs of increasing, members agreed that the risks to inflation, as well as those to growth, remained essentially balanced under an assumption of appropriate policy action."
The not-so-bad-news went only that far as
"...meeting participants were concerned that price pressures, which had been elevated before the storm, could climb further, primarily as a result of additional increases in energy prices."
And there are massively growing worries about the public debt which stood at $7.99 trillion as of October 10.
"With regard to fiscal policy, meeting participants noted that federal outlays would increase sharply in order to assist with recovery and reconstruction efforts in the aftermath of the hurricane. The eventual size of the increment to federal outlays was unclear, but it was likely to be quite large. The substantial step-up in government spending would add to federal deficits that were already large and underscored the worrisome loss of fiscal discipline evident in recent years."
This news comes on a day when Bloomberg TV elevated Treasury Secretary John Snow into the ranks of those that might succeed Greenspan as Fed chairman. Not exactly a reassurance that the administration will step up its efforts to rein limitless spending to a point where the public debt appears to become unsustainable.
The economy won't be of much help in rebalancing the US, the forecast expects.
"...the staff lowered its projection for economic growth over the remainder of 2005 in light of the economic dislocation associated with Hurricane Katrina. At the same time, however, the staff increased the growth rate forecast for 2006 to reflect the boost to economic activity from the rebuilding effort. By 2007, the level of output was expected to move back to the path it would have followed in the absence of the storm. The staff revised upward its forecast of overall inflation for 2005 and of core inflation for 2006, reflecting the effects of higher energy prices, but lowered its projection for overall inflation slightly for 2006. It was recognized that there were considerable near-term uncertainties and that many data series in coming months would be influenced by the effects of the storm."
There were no specific figures given, adding to the impression that the Fed is as clueless about the future development as all other mortals who see relatively robust earnings numbers in the corporate sector but share the macroeconomic sorrows of the the Federal Reserve System.
It has to be noted in this context that the FOMC took note of anecdotal evidence that lower-income households consumption may get further restrained by high energy prices. This could bring company earnings under renewed pressure from two sides: less spending and higher prices in a time when consumers have already been spending more than they earn.
A first conclusion of the meaning of the latest Fedspeak confirms the impression that growing inflation fears are taking hold with most Fed representatives as they have repeatedly voiced such concerns in the last weeks. See the posts further down in this blog. The dreadful picture has not changed for better and today's upward price action in energy markets combined with bond and equity markets heading south only reinforces my negative expectations for the US economy which will be the inflection point for a global downturn.
In case you are not convinced, check precious metals prices. Gold trades at an 18-year high, silver at this year's high and platinum at a 25-year high.
The markets hopes are right now hanging high on the release of the latest earnings numbers of Apple after the market's close. I want to add that a robust economy is not built on an admittedly innovative company which makes great products (this blog is produced on a Powerbook G4) but has yet failed to translate this into a bigger market share of the PC market and faces stiff competition in the audio devices market. Also take a look a your iPod and look where it is actually made!

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