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FOMC keeps rates unchanged; No sign of imminent start of tightening cycle

Thu, Jun 26 2008, 07:54 GMT
by KBC Market Research Desk

KBC Bank

• • FOMC keeps rates unchanged for the first time in seven meetings….

• • .....puts more emphasise on risks to inflation and inflation expectations....

• • .....but keeps downside growth risks ....

• • .... Dallas Fed governor Fisher dissents in favour of an increase of the Fed Funds target rate

• • ….markets reacts subdued, but near term rate hike is now very unlikely.

The FOMC decided to keep its rates unchanged yesterday. It was the first meeting in seven or the first time in 10 months, it didn’t cut its interest rates. The statement clearly shows that the Fed remains in an ackward position as it is confronted at the same time by lacklustre growth and recession risk, increased inflation risk and a financial sector that is severely weakened by the credit crisis, all three factors were mentioned in the statement.

In this context, the Fed stopped short from adopting a tightening bias, as it cited both downside risks to growth and increased upside risks to inflation and inflation expectations without calling one of them as a predominant risk. We conclude that the Fed has a neutral bias, but admit that at the margin they seem to take the inflation risk as being slightly more important than the growth risk, also as Dallas Fed governor Fisher dissented in favour of an immediate tightening. However, the Fed also restated in even firmer wordings that they expect inflation to moderate later this year and next year. In April, they expected it over the coming quarters.

All in all, the statement showed the stamp of chairman Bernanke, who laid down the body of the decision in speeches two weeks ago when he upped its warnings about inflation (and surprisingly the dollar) and said the downside risks to growth had diminished somewhat. It seems that the chairman and the FOMC want to talk tough on inflation to influence inflation expectations and avoid to have to walk the talk. The FOMC still seems convinced that in the end inflation will moderate. The Fed keeps all its options open and we suspect this to be the case also at the AuAugust meeting and maybe beyond. The eco and inflation data keep all their relevance for further Fed positioning.

Market reaction subdued and “logical”

As the statement was close to Bernanke’s comments of late and even Fisher’s dissent didn’t come out of the bleu the market reaction was subdued. However, the interest rate markets were positioned for a more hawkish outcome and thus when the prospect of an unchanged policy for longer became obvious, yields fell, the short end outperforming and driving the curve steeper. However, the FF futures show that some participants are still counting on an August rate hike. The August FF future trades at an implied 2.075%. The dollar lost some ground against euro and yen. Equities at first were marginally higher, but rapidly reversed the gains. All moves lacked technical significance though.

Fisher keeps dissenting, Plosser rejoins majority

Dallas Fed governor Fisher, a hawk, dissented in favour of a rate increase. It was the third consecutive meeting in which he wanted a more hawkish decision than the majority. The reasoning of Fisher for yesterday’s dissent won’t be known until the Minutes are released or he speaks about it, but in past speeches he clearly elaborated on his views. He fears for an adverse feedback loop in which lower rates weaken the dollar, push commodity prices and inflation higher, which lowers disposable income and so affects consumer spending.

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Published on  Thu, Jun 26 2008, 08:01 GMT

Archive

• FOMC keeps rates unchanged; No sign of imminent start of tightening cycle
  Published On Thu, Jun 26 2008, 07:54 GMT
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