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When is the Fed’s next move?
by Asha Bangalore
When is the Fed’s next move?
There is divided opinion about whether the Fed will raise the federal funds rate beyond 5.25% or stand pat before announcing a rate cut. As written in our various commentaries, we predict the Fed will hold the federal funds rate at 5.25% until the December FOMC meeting or possibly the January meeting. The nature of incoming economic data should provide sufficient evidence to justify lowering the federal funds rate by the end of the year.
The precise number of months that lapse between a pause and monetary policy easing is of less significance than the manner in which the economy evolves in the next few months. Nevertheless, there is considerable market talk about the numbers of months that have lapsed between a pause and a rate cut. Here is a short history of monetary policy changes focusing on transition periods during August 1987 (Greenspan’s term began in August 1987) and the present time.
(1) The federal funds rate was raised from 6.63% to 7.31% between Aug. 27 and September 24, 1987. This was followed by lowering the federal funds rate from October 22, 1987 - Feb 11, 1988 to 6.50%. In October 1987, a stock market crash was involved. There was a gap of about a month after the tightening before the Fed eased. During this phase, the federal funds rate was reduced by less than 25 bps on each occasion.
(2) The Fed raised the federal funds rate from March 30, 1988 - May 4, 1989 taking the federal funds rate to 9.81% from 6.50%. The next monetary policy change was on June 6, 1989 when the Fed cut the funds rate. The gap here again was about a month. It was with this change on June 6, the Greenspan Fed started on a 25 bps format. The Fed eased from June 6, 1989 to Sep. 4, 1992 taking the funds rate to 3.00%. They were mostly 25 basis points moves, with three 50 basis points cuts.
(3) The Fed raised the funds rate from 3.00% to 6.00% in short span (Feb. 1994 - Feb. 1995). After raising the federal funds rate on Feb. 1, 1995 to 6.00%, the FOMC eased on July 6, 1995 by 25 bps to 5.75%. The gap here was six months.
(4) After the July 1995 easing, the Fed brought down the federal funds rate to 5.25% by Jan. 31, 1996. It raised the funds to 5.50% on March 25, 1997. It held the funds rate at 5.50% until Sep. 1998 and cut the funds rate on Sep. 29, 1998 by 25 bps to 5.25%. The gap here was one year six months. The circumstances were special – Long-Term Capital Management crisis. Following this change, the Fed lowered the funds rate to 4.75% by November 1998.
(5) The Fed resumed tightening on June 30, 1999, taking the funds rate to 5.00%. It continued raising the funds rate until May 16, 2000 when the target funds rate was set at 6.50%. The next monetary policy action was on Jan. 3, 2001, when the Fed eased by 25 bps. The gap here was almost eight months.
Conclusion - In the five episodes of a shift from tightening to easing, a majority of the time the gap has been at least six months. This may or may not be repeated. Economic data will guide the course of monetary policy.
Latin American Elections: 9 Months & 7 ½ Presidents Later…
Our coverage of Latin America’s jam-packed political schedule has focused on market implications of a regional shift towards the ideological left. After eight presidential elections however, only one true Chavista has emerged victorious– Evo Morales of Bolivia. And his plans for nationalization have been stalled by inadequate funding and operating capacity at the state petroleum company! So, with only three elections still pending (Brazil, Nicaragua, and Venezuela) and the election rhetoric of left-leaning presidents being reined in by financial constraints (Morales, and Alan Garcia in Peru), can investors breathe a sigh of relief that the worst is finally over?
Let’s first look at Mexico where public protests and legal challenges have prevented an official declaration of a president-elect. Conservative candidate Felipe Calderon of the ruling PAN party narrowly defeated Andres Manuel Lopez Obrador (AMLO), a fiery anti-poverty campaigner and former Mexico City mayor, in the contested July 2nd presidential vote. Accusations of electoral fraud and the narrow margin of victory (244,000 votes, less than 1% of the 41 million ballots cast) sparked a variety of objections – including civil protests that have crippled downtown Mexico City – that eventually resulted in a partial recount at 9% of Mexico’s 130,000 precincts. Official results of the court-ordered recount are unknown, but both candidates have conceded that Calderon’s victory was upheld. AMLO, however, claims that evidence of fraud was apparent in the partial recount and refuses to yield to Calderon. He has asked supporters to continue their acts of civil disobedience until a full review of ballots has been ordered.
The strength of the opposition in Mexico highlights a theme that has been consistent throughout much of the region: leftist parties losing the presidential race, but making considerable gains in their support base. The July 2nd elections left Mexico with its most divided legislature ever. The traditional PRI party, which governed Mexico uninterruptedly for 71 years, lost its control in both chambers, ceding to Calderon’s PAN party. The PAN however, rules without benefit of a majority, holding only 206 out of 500 seats in the Chamber of Deputies and 52 out of 128 seats in the Senate. As the table below indicates, the real victor in the legislative elections was AMLO’s center-left PRD party. PAN gained 55 seats in the lower house and 6 seats in the Senate, but PRD gained 30 seats and 13 seats, respectively.
Election results were similar in Peru, where former president Alan Garcia (1985-90) narrowly defeated extremist Ollanta Humala in a second-round runoff back in June. Humala, who we have likened to Chavez and Castro, became a surprise candidate late in the game by defeating odds-on-favorite Lourdes Flores Nano of the center-right Popular Christian Party (PPC). He campaigned with a populist platform that supported the commercialization of coca production and increased government control over natural resource exploitation. (He also threatened to repeal the recently-signed FTA with the US.) His socialist rhetoric appealed to the struggling masses in Peru, where dissatisfaction with capitalist economic policies has grown after years of solid growth has yet to yield any substantial social improvement. Humala lost the presidency, but the aligned Union for Peru (UPP) party won control of the legislature with 45 out of 120 seats in the Congress of the Republic. The UPP won only 6 seats in the previous election!
The election outcomes in Mexico, Peru, and Bolivia clearly showcase the political gains the ideological left has made over the past nine months. Investors were relatively calmed by presidential results, but we argue that the underlying trends still highlight a risk of a regional shift back towards more socialist policies – in particular, easing of fiscal restraints that have, to date, led to an overall improvement of sovereign creditworthiness. Case-in-point, Belize. The small Central American nation announced an eleventh-hour debt restructuring to prevent what would otherwise have been an imminent debt default. Extensive hurricane damage and overly-expansionary economic policies left the Belize government strapped for cash. By restructuring its $960 million in external debt, the country hopes to minimize its servicing payments so as to avoid default. We recognize that Belize is a small, relatively isolated nation, but all of the countries discussed above (and then some) face similar economic challenges, i.e. a large debt burden, already-stretched economic policies, and a need for sizeable infrastructure rebuilding and/or improvement. Belize’s narrow economy and limited reserves made it an easy first victim, but if other nations are shifting back towards socialist largess, how long can they teeter along the same sharp edge?
