Interest Rate Roundup

Tuesday, May 09, 2006

The Fed: What it SHOULD do vs. what it WILL do

Tomorrow is the big kahuna -- Fed day. It's widely expected (by me and just about every other market participant) that the Fed will raise interest rates by 25 basis points to 5%. The federal funds rate has been marching higher since June 2004. But ask yourself: Is money really "tight?" I sure don't think so.

Would oil be at $70 if that were the case? Would gold be testing $700? Would CPI and core inflation be generally rising? Would the spread between TIPS and nominal Treasury yields be blowing out? Would various stock market indices be at all-time highs or close to it? Would the spreads between yields on high-risk debt and risk-free debt (Treasuries) be so tight? No.

The fact is, this is a non-tight tightening cycle. Inflation pressures have continued to build because the Fed has allowed too much money to chase too few goods and services.

What SHOULD the Fed do tomorrow? Put this "pause" talk to bed. Talk tough about inflation. Highlight that ALL of the inflation indicators they follow have pretty much gotten worse, not better -- and that financial conditions in the market are exceedingly loose.

What WILL the Fed do? That's the real question. I think it could go either way. Bernanke probably realizes he's rapidly becoming the laughing stock of the financial markets world. He and the rest of his Fed cronies keep talking about how "well-contained" inflation is ... while the market keeps making liars out of them. Maybe he takes this opportunity to sound tough.

On the other hand, the housing market is clearly imploding before our eyes. And the Fed continues to insist that the economy as a whole is going to slow any day now. These guys could throw out a bunch of platitudes and give the market what it wants -- an indication that a pause is right around the corner.

At least we don't have to wait very long to find out. 2:15 p.m. or so tomorrow is when the Fed news hits the tape.


Post a Comment

<< Home

Site Meter