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Federal Open Market Committee, January 29−30

Mon, Jan 28 2008, 08:13 GMT
by Luis Arregoces

BBVA Bancomer

• · The Fed is willing to act decisively to maintain orderly functioning in financial markets, and thus lower the risk of a sharper slowdown in economic activity
• · As a consequence of this strategy, FOMC will continue lowering the fed fund rates in the coming months
  

The FOMC lowered the fed funds rate by 75 bp last Tuesday, in a “decisive” action that could have been in the cards during the meeting ending on January 30, as the economic outlook deteriorated in previous months and “appreciable downside risks to growth” remain. The rate action implemented on Tuesday was probably intended to prevent a major stock market adjustment, which could have deteriorated even more the current outlook. A contraction in equity markets would have had an impact on consumer confidence and, if entrenched, an impact on consumer wealth.

President Poole voted against the rate cut because he “did not believe that current conditions justified policy action before the regularly scheduled meeting.” Many market participants interpreted Mr. Poole’s remarks as an indication that the Fed’s move had the specific purpose of “timely” reestablishing confidence in financial markets.

At the same time FOMC members seemed confident that core inflation is contained and inflationary expectations are well anchored. Currently, the balance of risks tilts towards lower growth rather than inflation, at least as long as long-term inflation expectations remain contained.

The FOMC statement has made it abundantly clear that more cuts are down the road. The likelihood of additional restrictions in credit to consumers and firms, for which there is some evidence, together with the disturbances in financial markets, which are not likely to ease in the near future, are an indication of future cuts in the fed fund rates.

Will the FOMC cut rates next week? It is hard to tell. On the one hand, the committee has done quite a few cuts, and at some point, members have to stop giving the impression that any additional piece of negative evidence is a surprise for them that merits further cuts. Nothing remarkable has taken place since Tuesday that could change the view that led them to cut rates. On the other hand, the market will have a hard time understanding the past statement, which stresses the need for timely action, as an indication of more rate cuts. As of today, the market discounts a 50 bp in the next FOMC meeting. If the FOMC decides to hold rates in this environment, it risks generating a stock and money market turbulence; likely, this is what the committee wanted to avoid by cutting rates last Tuesday (had it wanted to avoid these expectations it could have probably used other language in the statement). Next week is very important for market participants, in order to see what the FOMC wants and/or fears.

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Published on  Mon, Jan 28 2008, 08:20 GMT