Tuesday, June 29, 2004


A Quarter And No Change

I am shooting from the hip here, but we have been talking a lot about this at work. The U.S. economy is clearly growing, but not all indicators line up for the duck shoot. The take is that the Federal Reserve will hike rates a quarter percentage point on June 30 – no biggie there. It is a forgone conclusion. The FOMC could upgrade the chances of achieving sustainable growth over the next few quarters to better than even, in light of the fact that by most definitions we have already achieved it.

The big news once again will be the statement… if it comes with a change in bias.

Most people I have spoken to, and clearly most of them are at IDEAglobal, expect no changes in the balance of risk, assessments for growth, inflation or policy guidance. But policy guidance… well, there is a slight chance the Fed could deviate from the expected “measured pace” if inflation pressures pick up more quickly than now expected.

The May Federal Open Market Committee statement said output expanded at a solid pace and hiring appeared to be picking up. In the inter-meeting period, production growth was every bit as strong and more importantly April and May payroll reports demonstrated conclusively that a robust employment recovery is now underway. We therefore expected the labour market assessment to reflect this crucial development.

In the same period the FOMC found that inflation was beginning to stir. Not too worryingly so -- long-term inflation expectations appear to be well contained. But, inflation is the bond-holders biggest bugbear and so expect the Fed to refer to this issue, if only to suggest they have everything under control.

A 25bps hike and no changes to inter-meeting inflation assessment, inflation risk could help the market sharpen the view on what will happen in August, before the election, the end of the year, and by this time next year.

The Fed’s preferred course would be to curb inflation in the months ahead, not move again before the election, and the end of the year. If inflation comes in firmer than what is characteristic of price stability for a sustained period, the most we see as possible is 25bp more between the June meeting and the election and 50bp between the June outcome and the end of the year. Looking ahead, in the first half of 2005 the Fed could find itself in a position where multiple half-percentage point hikes are necessary to push back down on inflation.