GOLD RUSH

[sumisu]

The Fed's Dilemma

Wednesday April 30, 6:00 am ET

http://tinyurl.com/53jnjb

Much has been said about what the Federal Reserve will do today, but only one thing is certain: No one will be happy about it.
Federal Reserve policymakers are widely expected to end their two-day meeting with another quarter-point cut in interest. And investors will probably be satisfied with that.

It is the accompanying statement that is sure to disappoint.

"This is a case where words are going to speak louder than action," David Rosenberg, the Merrill Lynch economist, said.

The Fed is likely to signal that it is done with cutting rates for now—an expectation that gained widespread currency after Greg Ip of the Wall Street Journal reported last week that policymakers were shifting to such a view.

The Fed is apparently worried about creating expectations of easier credit that will fuel a fire already building in inflation. In speeches and testimony in recent months, Ben Bernanke, the Fed chairman, and other Fed officials have noted their concerns about rising energy and food costs, and they clearly see a need to tamp down that momentum given that it takes five months before a rate cut works its way through the economy.

Indeed, a small number of analysts have suggested that the Fed could even surprize the market and not cut rates at all today.

In its aggressive rate cuts earlier this year, the Fed said that the housing slump and the stability of the credit markets and their threat to economic growth outweighed concerns over inflation.

Yet that threat—illustrated by more grim housing data this week and by forecasts that banks will need to take additional write-downs and raise more capital—is still present. Many investors will see the Fed statement as abandoning a fight before victory is anywhere in sight.

At the same time, investors and analysts who have accused the Fed of being too accommodating to the markets and not paying enough attention to inflation may not be satisfied by a gradual shift toward a more hawkish stance.

As Barry Ritholtz on the Big Picture blog has noted, the growing body of evidence that inflation is anything but modest is "beginning to undermine confidence in the Federal Reserve."

To be sure, the Fed will want to indicate that it is keeping all its options open, by pointing to continued risks to growth.

A quarter-point cut would bring the Fed's benchmark, its target for the federal funds rate, to 2 percent, the lowest it has been since December 2004. In September, that benchmark was at 5.25 percent.

The crucial thing for the central bank is to persuade the markets that it is ahead of the curve.

Brian Sack, a former Fed economist now with Macroeconomic Advisers, said the surprisingly sharp rate cuts in January was intended "to convince markets that the Fed was on the job."

"Now you could be seeing the opposite," he said, according to the Wall Street Journal's Real Time Economics blog.