The US Federal Reserve’s credibility is on the line, and it’s a situation of its own making. Too many interest rate cuts, the rescue of Bear Stearns, the Federal Government’s $US120 billion tax stimulus, but above all, surging inflation, has put it in a position where it is unable to set a singular, easily understood policy for markets.
That saw it leave its Federal Funds rate steady at 2% overnight. It had no choice. Boosting rates would knock the fragile economy and financial confidence, while to cut rates would risk sending the dollar lower and inflation higher in the months ahead.
The Fed said: “Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased.”
But even on inflation it seemed to be hedging its bets, saying that while it now sees some measures of inflation expectations as “elevated”, it did not say that it saw expectations as rising. The US central bank highlighted higher oil as a risk to both inflation and growth.
Well, that’s been obvious for months and yet the language was a bit milder than some US analysts were expecting.
Of course, this is a dilemma of its own making. At the start of the month Fed chairman Ben Bernanke started trying to steady the value of the US dollar, and to switch the market’s attention away from the sluggish economy and uncertainty in the financial sector towards the rising inflationary pressures.
Surging oil prices plus rising food prices have seen the US Consumer Price Index jump to an annual rate of 4.2% in May and the Producer Price Index to more than 7%, so it was natural the Fed would want to make sure it had a handle on that emerging problem.
So Mr Bernanke talked about the value of the US dollar, backed up by comments from the Treasury Secretary, Hank Paulson: the dollar rose and yields on government bonds started a rise which took them up by more than 0.35% to a high around 4.26%.
But this attempt to steady the dollar and switch attention to inflation has been undermined by the head of European Central Bank, Jean Claude Trichet. He hinted very bluntly that the ECB was thinking of a small rate rise at its meeting next week.
A rise to 4.25% will undermine the dollar, boost commodity prices and add to the Fed’s woes, which can’t do anything meaningful except lift interest rates. Because that’s too hard at the moment, there’s nothing more Mr Bernanke can do but to talk tough.
A further problem for the Fed in the coming quarter is weaning US investment banks of the public teat of cheap money under a facility set up as part of the Bear Stearns rescue. That will concentrate tensions in the financial sector. Macquarie Bank strategist Rory Roberston said:
Market participants are slowly getting their heads around the fact that the Fed almost certainly will not be in a position to raise rates this year; even next year to me seems a stretch.
The hawks on the FOMC are rattling their cages, but I still think that the idea of the Fed hiking later this year is a complete hoax. The Fed will remain firmly on-hold. I could end up being spectacularly wrong on this, but one of the few apparent certainties in this game is the following simple rule: rising unemployment equals pressure to cut rates, and visa versa. To hike rates, the Fed effectively would have to argue that US unemployment is not rising fast enough!
The tone of the Fed comment on the economy didn’t betray a fear of recession: it was more satisfaction that the risks from the economy sliding further have eased.
If the Fed does lift interest rates later this year it won’t be because inflation is proving hard to control. It will be because the Fed wants to give the US economy the recession it has to have to slow activity and reduce price pressures by pushing unemployment up over 6%.
And, guess what? That’s what our Reserve Bank will be forced to do here if there’s any sign of a recovery in consumption and domestic economic activity over the rest of this year. It wants to see unemployment rising following the recent interest rate rises. It’s also prepared to cop a big inflation figure for the current quarter. But any rise in retail sales, a re-awakening in housing or a slowing in job losses will see the Reserve Bank is sorely tempted to give rates another 0.25% lift, and threaten more. Look for November to be the key month.
But there’s a fundamental difference between US and AU interest rates. We’ve been *increasing* them over the past six months or so, whilst the US has been decreasing them.
I know were are in the post Rudd era, but this journalist writes “And, guess what? …” Listening to the Prime Minister in Parliament is my ration of rhetorical questions.
I thought Crikey was the supposed to tell us what THEY wont. Here’s some news: Rory Roberston is “THEY”, and what he has to say is the usual utter rubbish. Repeat after me: “The Fed does NOT set interest rates – Markets do, and the Fed is always behind the eightball”. So regardless of FOMC meetings and what the Fed wants, it WILL be raising rates, otherwise 1) the bond market will kick it in the crotch, and 2) it will be shown up for the unick that it is when banks themselves continue to raise US interest rates. Also, I don’t see how on earth raising interest rates is going to “boost” commodity prices. The problem so far has been that low US interest rates and loose “liquidity” have allowed the Fed’s bastard Wallstreet buddies to exploit legal loopholes and artificially push commodity prices higher (witness GS & JPM recent record profit off the back of it’s Fed-funded looting operations in commodities). Raising interest rates is going to DECREASE commodities speculation and stop da Wallstreet boyz in their bankrupt IB’s from being able to go a-pirating. THAT is why the Fed doesn’t want to raise interest rates. It has nothing to do with ordinary people and how this crisis is affecting them and their families. It’s all about rescuing da boyz, and “liquidity”. South Korea’s CB has now finally had enough of inflation and is raising rates in an F-off to the Fed. And Trichet is going to do the same. The Fed WILL follow this year regardless of Ben’s need to keep throwing money at da boyz. Rory Roberston of course knows this and will be set to play it out after having told all the sucker newspaper who interview him, that the Fed will not raise.