Next FOMC Statement Could Sound Like This

Tuesday, June 24, 2008

Don't get too excited about the next statement of the Federal Open Market Committee (FOMC) that will rattle markets a short while after publication before the investment community will remember that any improvement in the real economy has not been in the cards since the April statement. Fed chairman Ben Bernanke and his fellows of the FOMC may have new - mostly worse - data points worth an extensive discussion.
But $139 crude oil and the housing/consumer credit/bank/ employment mess created by too much easy credit will not vanish by more helicopter drops that end up at banks who shore up their balance sheets while the rest of the economy is effectively shut out from the easy money game. A game that led the Fed to hold more than $400 billion in junk, pretending that these securities are worth as much as all the freshly digitized Federal Reserve Notes (FRN) banks were getting in exchange. Even the official consumer and producer price figures show that Bernanke and his fellows are way behind the curve as short maturity rates now pay negative interest.
How insane (or desperate?) are money managers to keep a game alive where it is clear that inflation is out of control and cannot be tamed by another 25 basis points change in Fed funds, regardless of the direction of such a move which appears to be very unlikely IMHO.
Check yourself at the Fed's website in the left menu bar the submenu "Policy Tools" where you will find six "tools" to direct the economy along the Fed's policy guidelines. These six terms basically all mean the same: More fiat money to help the finannce sector to keep their heads above the waterline. Hundreds of billions of new FRN's every month and the crisis only gets worse because you can't douse a fire with petrol.
Bernanke and his fellow decision makers actually have only one choice that may not work either: pray for a miracle that extinguishes markets in flames without drowning everybody at the same time. I doubt this will work.
It is clear that consumers cannot take a rate hike that would raise their mortgage payments. But it is also clear that another rate cut would send FRN's into an immediate tailspin. The only positive aspect would be a steepening of the yield curve, a situation loved by the banks who can borrow cheap on the short end while long-term lending and pocketing the rate differential.
This leads me to the conclusion that the Fed can only stay put in order to shield gyrating markets from high volatilities.

A Possible Version of the FOMC Statement
The FOMC statement, scheduled for release on Wednesday at 2 PM, could therefore sound like this:
The Federal Open Market Committee decided today to leave its federal funds rate unchanged at 2 percent.
Recent information indicates that economic activity may remain weak until later this year. Household and business spending has been subdued and labor markets have softened further. Financial markets are expected to remain under exceptionable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.
Readings on inflation have been deteriorating further and high energy prices as well as other indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.
The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.
Investmentwise I hold on to my projection that growing inflation fears will lend even more support to gold and last Monday's whacking of gold may have been a good entry point. Either my wallet is lying or inflation is raging. I suspect the latter is the case.


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