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September 19, 2005
John Berry's Fearless Prediction
My weekly report on how the market sees the near-term trajectory of monetary policy clearly suggests the sentiment that the Federal Open Market Committee will keep on keeping on. Bloomberg's John Berry says the market is right:
Federal Reserve officials are set to raise their target for the overnight lending rate tomorrow, and financial markets have gradually accepted that the devastation from Hurricane Katrina won't deter them...
Some analysts have suggested the committee might even punt as it did on the eve of the invasion of Iraq in March 2003 when it said that under the circumstances it couldn't assess the balance of risks to economic growth and inflation.
Others have predicted that the familiar words, "the committee believes that policy accommodation can be removed at a pace that is likely to be measured,'' will be scrapped, or that "accommodation'' or the notion of "measured'' rate increases will disappear...
Actually, there are good reasons to expect no change at all in that key paragraph in tomorrow's statement. First of all, removing the word "accommodation'' would imply that officials believe they have raised their overnight rate target as much as their need to. Or at least that they think that having boosted it by 275 basis points there is a good possibility they are done.
Given the level of inflation pressures in the economy, intensified by surging energy prices, that's a very unlikely conclusion for Fed officials to make at this point.
Second, what would the message to the markets be if the word "measured'' were removed? That officials were preparing to pause in their drive to move the overnight rate target to the so-called neutral level? Or that they were contemplating a 50 basis-point move at their November meeting?
Fed officials certainly don't want to send any unnecessarily ambiguous signals. And again, the degree of inflation pressure would argue against a wording change that could be interpreted as pointing to a pause...
Here's what to expect, says Berry:
What will change in tomorrow's statement is that the paragraph explaining how the committee views current economic conditions will undoubtedly expand beyond the usual brief comments on spending, labor market conditions and inflation.
In other words, the officials are going to describe how they expect the economy to evolve in the wake of the hurricane. While Katrina has made it harder to interpret current economic data, they are likely to say, as President George W. Bush said following a meeting with Fed Chairman Alan Greenspan shortly after the hurricane struck, that the overall impact on the U.S. economy will be "transitory'' and "temporary.''
That seems a less fearless call than the first one, so we'll ask him to put his money on the other prediction. we will know if he is right about 2:00 PM tomorrow.
UPDATE: More from Bloomberg:
Eighteen of the 22 firms that trade directly with the Fed predict it will raise rates for the 11th time since June 2004. Four say no change, the first time since May they have disagreed...
Sixteen of the so-called primary dealers said the Fed would retain its plan to raise borrowing costs at a "measured'' pace. Three firms said the word would be dropped and three didn't give a prediction. In a Bloomberg survey of 107 economists, 20 percent said the central bank will leave rates unchanged today.
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