It's "One More and Done" All Over Again Comstock Partners, Inc. Thursday, March 30, 2006
Although Wall Street was looking for more clarity in the FOMC’s first statement under Bernanke as well as a definite hint that the rate hikes were over, it got neither. As everyone has now noted, the policy paragraph in this week’s FOMC statement was exactly the same as in the January 28 release. In addition, while the wording of the Fed’s economic outlook paragraph was overhauled in an effort to show transparency, it was still virtually the same. The upshot is that the chorus is still singing “one more and done” as it has for the past year, and we still don’t know whether that will be the case. This is the Fed’s problem. It sees a solid economy that is generating increases in what it terms “resource utilization” combined with “elevated” prices of energy and other commodities. It therefore sees the necessity of “further policy firming” (read rate rises) to slow the economy down to a point where inflationary pressures ease. As long as the economy remains solid it puts further pressures on resource utilization, and this means more rate hikes until such time as the Fed is convinced that the economy is slowing. That is why the outlook for future monetary policy is said to be data dependent. But how will the Fed know when the economy is slowing down enough to stop hiking rates? That’s easy. They will watch the data, meaning employment, consumer spending, housing, capital investment and prices. The problem is that with the exception of housing—which is already slowing down—most of the data the FOMC looks at in making policy decisions are coincident or lagging indicators. By the time these indicators slow down, the ongoing course of the economic cycle is almost set in cement as the leading indicators such as rising interest rates, the yield curve and energy prices are already signaling danger ahead. Therefore, by the time the Fed stops raising rates the economy is already on a course leading to probable recession, and the stock market is likely to shift its attention to faltering economic growth and disappointing earnings rather than cheer the end of tightening.
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