FOMC Minutes Sound Less Dovish Than Markets Read It

Tuesday, November 22, 2005

The latest FOMC minutes have been greeted by equity markets with solid gains. But is the language really as dovish as Wall Street interpreted it initially?
Reading and re-reading the minutes I take note the FOMC stresses two points; ongoing inflationary risks from elevated energy prices - chairman Alan Greenspan said in July that $60 oil would shave 75 basis points from GDP - and robust economic growth bolstered by a rapid pace of productivity gains. This does not sound dovish to me and the paragraph that made stocks rally is not conclusive either.
The FOMC talks about a change in the language for the rate outlook, stressing that this has to be in context with (robust) economic growth and (dangers of higher) inflation.
I do not consider this as a sign that the Fed will stop the rate hike cycle that soon, also remembering the latest Fed speakers who all pointed to the factors already noted twice. To send the Fed's message a third time: Good growth accompanied by inflationary dangers.
The key paragraph from the FOMC minutes:
In their ongoing discussion of the Committee's communication strategy, participants expressed a variety of perspectives about how the policy statement issued at the end of FOMC meetings might evolve over time. Several aspects of the statement language would have to be changed before long, particularly those related to the characterization of and outlook for policy. Possible future changes in the sentence on the balance of risks to the Committee's objectives were also discussed. Participants noted that any forward-looking elements of the statement should clearly be conditioned on the outlook for inflation and economic growth. For this meeting, members concurred that the current statement structure could be retained, as it accurately conveyed their near-term economic and policy outlook.
While Eurodollars immediately took the notion of a change in coming Fed interest rate releases as a primer to see Fed funds not going higher than 4.5% I doubt that the rate train will drive into the garage at this level. This paragraph can also be seen as a preparation for a 50 basis point hike which would help chairman designate Ben Bernanke establish a hawkish reputation. Several Fed members have in the past hinted that the neutral zone might lie somewhere between 4 and 5%, given that economic coditions remain at the levels seen currently.
If the economy remains at its brisk pace seen in the third quarter - the 3.8 growth rate is subject to two revisions - there is no reason to for premature optimism.
Recent consumer surveys all point to a maybe frugal christmas shopping season in the light of rising necessinflation (inflation is low but everything we buy has become more expensive) and stagnating personal earnings. If this outlook becomes reality, combined with a more markedly slowdown in the housing market, the Fed could boost optimism with a pause in the cycle. If oil prices remain high - and the winter season can already be felt through crude oil prices rising again - the pause cannot last long if the Fed wants to remain credible in its inflation fighting efforts. Looking at corporate profits which have been rising in all three quarters of this year further rate hikes certainly can be accommodated in the balance sheets of those who have not leveraged their capital too much.
There are too many ifs in the outlook as that I could take anything for granted.
Of note is also that gold rose after the release of the minutes. According to a study which I can't source now gold and inflation have a positive correlation coefficent of 0.7 since the 1950s. So what is the shiny metal, just short of an 18-year high, telling us?


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