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Fed Open Market Committee, September 18th

Mon, Sep 17 2007, 08:43 GMT
by BBVA FX Team

BBVA Group

• Disappointing employment numbers for August lead many economists to curb their short-term forescast on economic activity
• A rate reduction is needed in order to avoid a hard landing

Recent developments in the short term economic outlook have many economists asking for a rate reduction in the next FOMC meeting. The latest indicators offered a mixed picture on the short term prospects for the economy. August employment report showed weakness in many key sectors other than construction; temporary employment lost almost thirteen thousand jobs and manufacturing lost almost forty six thousand, while the service sector decelerated, drastically, from the previously high job creation rate. The strength on the employment numbers from previous months was considered a significant resiliency factor for future economic growth. The disappointing numbers for August leave a bitter taste for those expecting the markets to adjust via self- correcting mechanisms without external intervention.

In his Overview and Concluding Remarks presented at the Fed’s Jackson Hole Symposium, Martin Feldstein1, said that “there are two reasons for a major reduction now in the federal funds rate”. Early this week he referred to the increase in the likelihood of inflationary pressures generated by a rate cut as “the lesser of two evils” when compared against the possibility of a hard landing for the economy, if no action is taken by the Fed next Tuesday. Three Fed officials expressed last Monday their opinions regarding the negative effects of the current market turmoil on the overall economy. Janet Yellen said in her speech to the National Association of Business Economics that current financial market turmoil has added to downside risks for the economy. Dennis Lockhart, stepped back from his previous position about current economic conditions when he said that available data was not providing conclusive signs that housing problems were spilling over into other sectors of the economy; neither Yellen or Lockhart are voting members of the FOMC. Frederic Mishkin in his speech at New York University said that a retrenchment in equity markets combined with the decline in house prices have dampened, this year, gains in household wealth. Also, he believes that the inflation outlook looks “more balanced, given the greater downside risks to real growth.”

In summary, we revised our expectations on a FOMC rate cut to 50 bp next week. In the event the Fed cuts rates by only 25bp, another cut will be needed in the October meeting. Thus, we maintain our forecast of a total reduction of 50 bps to 4.75% in the remaining of 2007.

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Published on  Mon, Sep 17 2007, 08:45 GMT

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