Divining the Meaning of "Yet" Comstock Partners, Inc. Thursday, May 11, 2006
The parsing of every word and comma in FOMC meeting statements is getting more and more ridiculous. This time the main debate appears to revolve around the insertion of the word “yet”, as in the sentence stating that “The committee judges that some further policy firming may yet be needed…”. When new chairman Bernanke promised more transparency from the Fed, Wall Street apparently thought that the central bank would issue a definitive blueprint as to what action it would take at any given future meeting. As it turns out, the upcoming June meeting will be the first in a long time where we don’t know what the outcome will be.
In our view, however, the Fed was perfectly clear in stating that it actually doesn’t know what it will do next, and that future action will depend on incoming data. With the next meeting still seven weeks off, there is still almost two months of data to come before we get a better clue to forthcoming action. If the economic slowdown that the Fed expects shows signs of occurring and inflation is controlled, they will most likely pause in its series of rate hikes, and wait to see what happens next. If not, they will raise rates at the next meeting. So the possible sequences of future rate actions are either: pause with no further increases; pause and increase rates later; or keep raising rates. What the Fed is telling us is that they don’t really know what they are going to do and are keeping their options open. At the moment that is about as transparent as they can get.
All of the above, however, misses the big picture as the Fed is still faced with an ongoing dilemma that it may find difficult or impossible to solve. This is something that we have been writing about for a long time, and is actually evident in a careful reading of some of the changes in the latest FOMC statement. For the first time the statement mentioned the cooling of the housing market, adding that factor to the lagged effects of increases in interest rates and energy prices in forecasting a moderation of economic growth. On the other hand they eliminated the usual balance-of-risk statement, choosing to single out inflation as the main risk to their forecast.
Therefore, the Fed is faced with a softening housing market on the one hand, and potential inflation on the other. Since booming house prices and the conversion of these prices into ready cash was a major underpinning of the economic recovery, any weakening in this segment is likely to cause a significant economic slowdown or recession. But if the Fed stops hiking rates, inflation can well get out of hand. Although the government’s conventional statistical measures of inflation remain under control, it is evident that gold, energy and industrial commodities are soaring even as we write, while the dollar appears to be falling off a cliff. A large number of companies have started to pass these price increases along, and many more plan to do so soon. At the same time, according to ISI, 76 global central banks have announced tightenings, the same as prior to the 2001 recession. In our view all of these conflicting forces are getting beyond the Fed’s ability to control, and the chances of a soft landing for either the economy or the stock market are rapidly receding.
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