Brief News For Hawks And Doves From The FOMC

Wednesday, May 10, 2006

The Federal Open Market Committe (FOMC) unanimously hiked the Fed Funds rate as widely expected by 25 basis points to 5%, the 16th baby-step in a row. The accompanying, very brief statement again had something for both doves and hawks.
Doves will love to read that
"The Committee sees growth as likely to moderate to a more sustainable pace, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices."
Their case gets reinforced by the Fed's tame view on the run-up in commodity prices.
"As yet, the run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation, ongoing productivity gains have helped to hold the growth of unit labor costs in check, and inflation expectations remain contained."
Hawks will underline the next sentence of the statement.
"Still, possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures."
The up-trend of Fed funds will remain intact and still correspond with my expectation to see Fed Funds between 5.25% and 5.75% later this year, although a pause may be imminent. I expect to see the Fed pause at the current level as they need time to assess the impact of the past rate hikes which can clearly be felt in the property market.
"The Committee judges that some further policy firming may yet be needed to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information."
Given the conflicting outlook presented by stubbornly low inflation data and record commodity prices the Fed may be happy to pause in June and delay further ARM rate increases by 3 months this way. Such a non-move could be seen as wrong self-complacency if commodities deliver another summer rally this year.
The weak position of the US dollar narrows the options of Bernanke & Co too. Once forex markets get the idea that the Euro will narrow its rate differential the US dollar will probably slide to the old lows at $1.36/Euro.
Today's sharp reversal in crude oil will keep policy makers on their toes. And my surefire indicator for troubles ahead, gold, just marked another 25-year high at $705. I will keep that position.


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