The economic/inflation data continues to be mixed and the economy’s “turn signals” seem to be flashing left, right and caution all at the same time. In this environment, the notion of a “pause” in interest rate hikes has now taken on a life of its own.
The market is no longer focused primarily on when the Fed will “un-pause” and start increasing rates again, but rather how long it will stay in neutral and whether there may be cause (by way of recession risk – see, among other, Mr. Greenspan) to perhaps begin lowering rates. Yet the Fed maintains consistent in its meeting statements and public commentary that it views inflation as the primary risk, not a slowing economy, while acknowledging some risk of the latter.
In that context, the Fed is in a bit of a bind and seems to be reasoning by resorting to a kind of “paper-jawboning” of the market in terms of inflation, even to the extent of using its release of meeting minutes as a kind of “virtual rate increase” by way of the emphasis stated therein that it continues to be concerned about price increases outside of its comfort zone, even while continuing its internal debate as to whether it should publish and adhere to a targeted range of inflation against an identified measure that would compel (and thus foretell) its action no matter what the state of the economy or the job market might be from time to time (as is supposed to be done in Europe and some other countries). In that context, perhaps the market is more than a little grateful for the Fed’s unpredictability (aka “data dependence’).
The main point is that the Fed can’t really risk raising interest rates now for fear of pushing the housing market into free-fall (and triggering a “Bernanke Recession”), but cannot say it is satisfied with current inflation levels (although there is some evidence of a pull-back in prices away from energy and food) for fear of saddling-up the bond vigilantes in terms of perceptions that the Fed is going soft on inflation. So it “talks” a good anti-inflationary bias by means of its minutes and hopes that suffices to damp down any inflationary expectations in the pricing market without seeming to do so by signaling any lack of confidence in economic growth going forward (which could be a self-fulfilling prophesy).
While the market participants are watching the Fed, the Fed also wants to watch market participants, at least in terms of what private economists and perhaps more importantly CEO’s are saying about the direction of the economy. Thus , although Fed policy seems like it is made in an August conference room in DC, but it is really made in a Hall of Mirrors on the economy (some with ‘fun-house’ distortions like the recent release of preliminary (not to say “premature”) first quarter GDP figures showing a meek 1.3% increase. The only thing we know about that number with reasonable certainty is that it is wrong, as most recent early quarterly estimate have proven to be: often by very large percentages.
Why the Government continues to release such deeply-flawed “statistics” (with their concomitant influence on the public equity and debt markets for good or ill in terms of billions of dollars in instant trading gains and losses) is beyond reason. The early numbers on GDP are mostly “quarterizations” of two-month data which itself is often also corrected by the time the next, usually more reliable GDP number is released (see the end of May).
Nonetheless, like all of official Washington, the Fed must fight its war “‘with the data it has” – and market participants can only guess along with the Fed at least until the minutes of the meeting come out and we see the full range of data the Fed was looking at before its rate decision, and more importantly, see what factors it chooses to emphasize in its minutes. If the Fed really wants to send us a message that is more nuanced than its post-meeting script, that’s where it probably will be found.
Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.
