FOMC Keeps "Measured" Language - Leaves Room For Speculation

Tuesday, November 01, 2005

As widely expected the Federal Open Market Committee (FOMC) unanimously raised the Fed Funds rate for the 12th consecutive time another 25 basis points to 4 percent.
Of note is the fact that the FOMC sees monetary policy as accommodative again; a stance it had omitted in the September statement.
The Fed's hint about "robust underlying growth in productivity" should be confirmed on Thursday when the next set of productivity data is due.
As the Fed sees monetary policy accommodative it opens the leeway for the next meetings to the upside. Coupled with the recent surprisingly positive GDP figures for Q3, strong construction spending (released today) and the note about upward pressure on prices despite stable core inflation this statement leaves room for speculation whether the Fed will abandon its baby step policy in favor of a 50 basis point move sooner than later. Even if the Fed keeps to its "measured" path, see the Fed Funds rate at at least 4.50% by the end of January; remaining close to the lower end of the "neutral" spectrum that reaches further than 5%.
Former Fed governor Ed Gramlich agreed on Bloomberg TV that overnight rates still appeared fairly low.
While core inflation remains low, consumers have begun to feel the pinch nonetheless. Headline inflation roars ahead at an annual rate of 4.7%; a rate last seen at the beginning of the 1990s, according to historical data from "Inflation Central" at the Fed Cleveland.
Equity markets went into a shortlived rally after the announcement and gave up their gains half an hour later. The 10-year Treasury future declined, yielding 3 basis points more at 4.58%. The dollar remained unchanged vs. the Euro.

US Yield Curve 10/31/05

GRAPH:A look at the yield curve shows that the Fed has managed to induce a parallel up-move since summer when analysts feared an inversion of the yield curve; a development which has preceded all past recessions. Chart courtesy of The Bond Strategist.

The Fed also has to watch developments in the Euro area. Runaway money supply growth and inflation hovering markedly above the leading Euro interest rate might force the ECB to a first rate step as early as this December, analysts were quoted in a Wall Street Journal Europe report from Tuesday.
Comparison Of November and September Statement
The latest statement is one paragraph shorter than the previous one but very similar to the one from the meeting in August.
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 4 percent.
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 3-3/4 percent.
Elevated energy prices and hurricane-related disruptions in economic activity have temporarily depressed output and employment. However, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity that will likely be augmented by planned rebuilding in the hurricane-affected areas. The cumulative rise in energy and other costs have the potential to add to inflation pressures; however, core inflation has been relatively low in recent months and longer-term inflation expectations remain contained.
Output appeared poised to continue growing at a good pace before the tragic toll of Hurricane Katrina. The widespread devastation in the Gulf region, the associated dislocation of economic activity, and the boost to energy prices imply that spending, production, and employment will be set back in the near term. In addition to elevating premiums for some energy products, the disruption to the production and refining infrastructure may add to energy price volatility.
While these unfortunate developments have increased uncertainty about near-term economic performance, it is the Committee's view that they do not pose a more persistent threat. Rather, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. Higher energy and other costs have the potential to add to inflation pressures. However, core inflation has been relatively low in recent months and longer-term inflation expectations remain contained.
The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.
The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.
Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Roger W. Ferguson, Jr.; Richard W. Fisher; Donald L. Kohn; Michael H. Moskow; Mark W. Olson; Anthony M. Santomero; and Gary H. Stern.
Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Roger W. Ferguson, Jr.; Richard W. Fisher; Donald L. Kohn; Michael H. Moskow; Anthony M. Santomero; and Gary H. Stern. Voting against was Mark W. Olson, who preferred no change in the federal funds rate target at this meeting.
In a related action, the Board of Governors unanimously approved a 25-basis point increase in the discount rate to 5 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.
In a related action, the Board of Governors unanimously approved a 25-basis-point increase in the discount rate to 4-3/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Richmond, Chicago, Minneapolis, and Kansas City.

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