Your Economy (No Politics)

[Bullwinkle]

Fed Minutes Reveal Nothing New
Comstock Partners, Inc.
Thursday, January 5, 2006


The minutes of the December FOMC meeting, released this week, contained nothing we didn’t already know. The key sentence that the markets focused on stated that “Given the information now in hand, the number of additional firming steps required probably will not be large.” That the view was not unanimous was indicated by attributing that view to “most members”. We already knew from the post-meeting statement that the prior reference to policy accommodation was left out, meaning that the Fed now believed its current policy was neutral. Since the consensus was previously looking for an eventual funds rate of 4.75% with most estimates falling into the 4.50-5.00% range, little or nothing has really been changed by the minutes. With the rate now at 4.25%, it’s obvious that another increase brings us right into the bottom of the range, and two more hikes bring us into the mid-point.

Even those estimates are not set in cement. The minutes further stated that “Views differed on how much further tightening would be required. Members thought the policy outlook was becoming increasingly less certain and that policy decisions going forward would depend on to an increased extent on the implications of incoming economic data.” It seems clear that all the Fed did was eliminate language that would have painted themselves into a corner. This gives them the flexibility to base future rate decisions on the incoming data rather than being locked in by previous statements. Since they say that the pattern of this incoming data is “uncertain”, and the members themselves disagree, we still don’t really know when they will stop raising rates.

In our view the key point is that rates are still rising and the yield curve is in the process of inverting. For valid reasons, these are indicators that have almost always led to economic slowdowns or recessions in the past. As we have believed for some time, the Fed is still trying to walk a tightrope between economic growth and inflation. Any serious downturn in home prices or even the lack of further increases could kill the golden goose that supports U.S. consumer spending and the entire global economy. On the other hand, a continuation of the boom would stimulate the migration of high energy prices into a wide array of goods and services, making even more restrictive monetary policy necessary down the road. In this connection a strong employment report tomorrow morning could cause the rate target to rise while a weak report would have the opposite effect, but would result in weaker economic forecasts.

It is highly likely that the peak in the housing sector has already occurred, and that the slowdown will spread to consumer spending and the rest of the economy. Depending on how fast this happens, the Fed may very well stop tightening after the next meeting or two, but it won’t be a result of the wording of the Fed’s minutes. Rather, it will be a result of increasing economic softness that leads to disappointing corporate earnings, an event for which a highly overvalued stock market is totally unprepared. The end of the rate rises will therefore not be greeted by a relieved stock market, but by a market severely disappointed on the prospects for a sluggish economy and disappointing earnings.

http://www.comstockfunds.com/index.cfm/act/newsletter.cfm/CFID/3100225/CFTOKEN/15616716/category/Mar...