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.

Monday, June 28, 2004


We woke up this morning to news that the Iraqi interim government was handed the keys to the country by U.S. administrator Paul Bremer two whole days ahead of schedule. The idea in doing so, ostensibly, was to pre-empt insurgents from springing a nasty surprise on Wednesday and spoiling the transfer party – That would have been egg in the face for all concerned.

Does this mark the end of the occupation? I don’t think so, though many will say that it does. With more than 130,000 American troops and thousands from other nations still in Iraq, Iraq’s "sovereignty" will be severely circumscribed. And while they will be a less visible presence – the foreign soldiers will still be there.

So what has the five-minute ceremony brought Ghazi Ajil al-Yawer and interim Prime Minister Iyad Allawi and indeed Iraq? A head start on militants for one; but more importantly, it gives the interim government the moral ground to make sovereign decisions and bring their nation much-desired peace. This is also the first sign from the Bush administration that it recognizes the reality on the ground, and is moving to render unto Iraqis’ what’s theirs.

While the White House is congratulating itself on its perspicacity, the claims that first brought the U.S. into this war ring ever more hollow. The weapons of mass destruction, the principal reason for going to war, were never found. The much trumpeted aim of bringing freedom to Iraq is ever more distant – violence is endemic and all the signs that mark freedom, a distant memory. Iraq’s infrastructure is in the stone-age, jobs are scarce and Iraqis desperately poor.

The Bush administration’s prediction, at the start of the war, that it would be greeted as liberators now appears to have been premature. There is little love for the U.S. today in the fertile crescent. The Sunnis understandably hate the occupation, the Shias are suspicious and angry and Kurds in the north, once unquestionably allies, are questioning the administration’s motives.

The administration, it appears got the tactics right, but tripped over strategy. Defense Secretary Donald Rumsfeld was only partially right when he said, Iraq could be taken and held with a small, highly mobile force. Winning the war was fairly easy – it was keeping the peace that the allies failed miserably at.

The decision to disband the Iraqi army instead of simply purging the Baathist elements in hindsight appears to have been the perfect recipe for the chaos and unrest that followed. Into the void left by the army flowed in Islamic militants and other vested interests. Instead of becoming the crucible of democracy in the Middle East, that Bush publicly said it would, Iraq has become the proving ground for Jihadi elements.

In Iraq itself the mood is somber -- no celebratory bursts of gunfire, no speeches, parades or parties. The people are weary, worried and watching.