As I have said before, my view on the FOMC has gone cloudy. That said, I’ll put forth my best guess for you what the FOMC will do and say today. I think the FOMC will ease the Fed funds target 25 basis points, or maybe a little more, but not 50 basis points. (Stuck my neck out there, hope I don’t get chopped.) Here’s why:
- Not all lending crises are over, but the crisis in the CP market largely is over. There was some paper that had to be taken back by the banks, and some that had to be rolled over at relatively high rates, but the refinancing of the bulk of short term credit is done for now.
- Total bank liabilities are growing smartly since the change in the discount window, leverage changes, and temporary liquidity adjustments took effect. Little effect on the Fed’s monetary base, M1, MZM, or M2 yet. This is just a bank leverage thing.
- The NY Fed Open Markets desk continues to be sloppy on the upside. Over the last four days, three times Fed funds finished over 5.25%, with the close yesterday at 5.4325%. This is not what you would expect to see from a Fed that expects to loosen aggressively.
- The discount window finally got good demand last week. With that strategy seeming to work, the FOMC has less pressure to cut the funds rate. Might they cut the discount rate more than the funds rate? Yes. because seeming success often breeds more of the same.
- Business conditions aren’t that bad nationally yet. Real estate is a drag, and will get worse, but it is not an immediately obvious reason to loosen.
- A 25 basis point move validates the temporary policy move of the Fed, and does not change policy, beyond making the more semi-permanent.
- There are more hawks with votes on the FOMC now, and Bernanke is not pushing to get his way, the way that Greenspan did.
Beyond that, we have the language of the statement, where the FOMC will attempt to sound a balanced view between the risks of inflation and economic weakness. After the announcement, I expect the stock market to fall back and then rally modestly. Bonds won’t do much.
That’s my view, though I must state that this is not one of my more strongly held views. I am still gathering data on the current Fed, because they are so new to their roles in loosening environment.