Fed May See Katrina Inflation Risks Outweighing Slowdown Fears
*The bulls & bears will be duking it out this week... and I say the Fed hikes still continue...
Fed May See Katrina Inflation Risks Outweighing Slowdown Fears
Sept. 6 (Bloomberg) -- The Federal Reserve is likely to conclude that Hurricane Katrina poses more risk of inflation than of an economic slowdown, and probably will raise rates on Sept. 20 while signaling it may pause later if there are lingering effects on growth and hiring.
``If you look at the record at how the U.S. has weathered shocks, we have a very, very resilient economy,'' Harvey Rosenblum, director of research at the Fed Bank of Dallas, said in an interview. Fed policy makers are likely to weigh their response to Katrina against how strong the economy was before the storm. ``Initial conditions matter,'' he said.
Current and former Fed officials also are stressing odds that any slowdown will be temporary, and emphasizing their reputations for keeping inflation at bay. Together, the comments suggest policy makers aren't convinced they need to stop raising rates, even if their Sept. 20 statement is reworded to give them more room to pause later if data warrants.
``From 1994 and on, we have managed to convince markets we are capable and willing to do what it takes to prevent inflation from getting out of control,'' Richmond Fed Bank President Jeffrey Lacker said in an interview. The Fed's credibility helped keep Americans' price concerns anchored even as gasoline costs jumped 38 percent in the year's first half, he said.
Neither Rosenblum nor Lacker, who is a nonvoting member of the Federal Open Market Committee this year, would offer predictions on the path of interest rates. Anthony Santomero, a voting member and Lacker's counterpart at the Fed Bank of Philadelphia, said in a speech after the storm that he expects the Fed to keep raising rates at a so-called measured pace.
More to Say
Fed Bank of Chicago President Michael Moskow of Chicago will comment on the economy in a speech scheduled for tomorrow in Chicago at noon local time. San Francisco Fed President Janet Yellen of San Francisco will speak on the economy the next day.
Investors changed bets about the path of interest rates after Katrina struck, predicting Fed officials will stop raising the nation's benchmark rate after the Sept. 20 meeting, the first of three left this year.
The FOMC raised the overnight bank lending rate 10 times since June 2004, to 3.5 percent, in an effort to head off faster inflation. Before the storm, forecasters in a Bloomberg News survey unanimously predicted another rate increase on Sept. 20; now 12 of 77 expect no change.
The FOMC was already concerned about ``greater near-term momentum'' in the economy, resulting in ``elevated inflation pressures,'' according to minutes of their last meeting, held Aug. 9. Katrina struck 20 days later, and the average U.S. pump price for gasoline rose more than a half-dollar to a record $3.057 a gallon on Sept. 2, the AAA, the nation's largest motoring organization, reported.
Refinery Damage
U.S. consumers are likely to pay $3 a gallon or more for gasoline for at least ``the next six to eight weeks'' because of refinery damage, Ben Bernanke, President George W. Bush's chief economic adviser, said Sept. 1.
The debate around the Fed's boardroom table on Sept. 20 is likely to focus on the duration of disruptions to U.S. ports, logistics and energy supplies, rather than on the possibility of significant impairment to growth.
Louisiana and Mississippi account for around 2 percent of U.S. output. About 30 percent of U.S. oil production comes from off-shore platforms in the Gulf. About 7 percent of the nation's refining capacity is still off line a week after the storm, according to the U.S. Minerals and Mining Service.
Meeting With Greenspan
Bush and Treasury Secretary John Snow both said they met with Fed Chairman Alan Greenspan last week and that he shares a view that economic disruption may be temporary. Greenspan hasn't spoken publicly since the storm.
While Katrina ``does seem to be at the large end of the scale of disasters we have seen,'' the economic impact is ``very localized geographically'' aside from the spike in gasoline prices caused by pipeline and refining disruptions, Lacker said.
A pause in the rate cycle will at least be discussed at the September meeting, said Brian Sack, a senior economist at Macroeconomic Advisers LLC and former head of monetary and financial markets analysis for the Fed Board of Governors.
``This is very much a developing story,'' Sack said in an interview. ``It is hard for any Fed official to say how temporary the effects are going to be.''
`Significant Commentary'
The FOMC is likely to add ``significant commentary'' about the near-term outlook in its statement and signal that future policy discussions will give added weight to new data, former Fed Governor Susan Phillips said in an interview. Around the start of the Iraq War in March 2003, the committee pledged ``heightened surveillance'' of data and regional anecdotes.
``All of those Fed presidents'' will be dialing business contacts and ``come in with their stories,'' said Phillips, now dean of the George Washington University School of Business in Washington. ``The Fed does need to have rates higher. The question is: At what pace do you do it?''
At a minimum, rising fuel costs and supply disruptions from the hurricane ``makes the economy more vulnerable to other shocks,'' said Rosenblum, the Dallas Fed researcher. ``You have an economy that has no tail winds from monetary policy,'' and so ``other shocks can depress demand.''
U.S. Secretary of Labor Elaine Chao said weekly jobless claims are likely to rise for ``several weeks'' from a weekly average of 317,000 applications over the past month. As far as the national impact of the hurricane, ``it's a little bit early to say,'' Chao said in a Sept. 3 interview.
Trimmed Forecasts
Economists at Lehman Brothers Inc. and Bear Stearns & Co. trimmed their forecasts for third-quarter output, while maintaining the view that the U.S. central bank will raise rates over the final three policy meetings of the year.
``We need to remember the Fed's job is not only to manage growth in the economy,'' Lehman Chief Economist Ethan Harris said in an interview. ``They also have to keep an eye on the inflation picture. They can't just step aside if they see a major inflation shock coming out of this episode.''
The consumer price index rose 3.2 percent for the 12 months ending July. One measure of inflation expectations, derived from yield differences on U.S. Treasury 10-year notes and government inflation-protected securities of similar maturity, show traders in the second quarter expected prices to rise 2.48 percent, down from an average of 2.59 percent annual rate in the first quarter.
A Larger Bulge
``We think the cost of a pause would be a larger bulge in inflation,'' John Ryding, chief economist at Bear Stearns in New York, said in a note to clients.
Lacker said the current surge in energy costs won't trigger ``threshold effects,'' where total spending begins to contract. Retail sales rose 1.8 percent in July and 1.7 percent in June, the largest back-to-back gains since 1993, even as the average price of gasoline rose 15 percent in the same period.
Consumers are more focused on their income prospects than on inflation and ``that is the predominant determinant to their spending,'' he said.
The economy slowed to a 3.3 percent annual rate of growth in the second quarter from 3.8 percent in the first quarter. Prior to the hurricane, both private economists and the Fed board's staff expected the economy to pick up speed, with a Bloomberg survey completed Aug. 8 showing a median estimate of 4.1 percent growth in the third quarter.
Lehman's Forecasts
Lehman dropped its forecast for third quarter growth to a 3.8 percent annual rate from 4.5 percent, and increased its year- end forecast for the consumer price index by 0.8 percentage points to 4.1 percent. Bear Stearns cut its third-quarter growth forecast to 3.5 percent from 4.5 percent.
With so much in flux, there will be greater scrutiny of Fed officials' statements, such as those of Moskow and Yellen, between now and Sept. 20. Fed officials traditionally stop speaking in public a week before a policy meeting.
``There is a lot more uncertainty in forecasting both the economy and the Fed right now,'' economist Harris said. ``The economy should be in reasonable shape and the Fed, which was in a very hawkish mood going into this period, probably just continues hiking rates.''
To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net.
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