Last night’s post got eaten by a loss of power.  It’s time to return to “FOMC mode” in anticipation of the meeting ending on the 31st. Let’s review the data as I see it:

• Even with the recent loosening in FOMC policy, the Fed still hasn’t done a permanent injection of liquidity since May 3rd.  Growth in the monetary base since then has been anemic.
• The narrow monetary aggregates have not been growing rapidly, even since the FOMC began its temporary liquidity injections back in August.  Even M2 has been flat.
• My M3 proxy has not been flat, though it overstates matters somewhat.  Total bank liabilities have grown 4% since mid-August, which is close to a 20% annualized rate.  This has to be taken back a bit, because with the Treasury-Eurodollar [TED] spread around 110 basis points, liquidity from the unsecured Euro-dollar markets has diminished.  How much for US banks?  I’m not sure; I can’t find a data series for that yet.
• The TED spread has retreated 65 basis points since the last meeting.  Things are better, but external dollar liquidity is still tight, which in my book means a TED spread above 60 basis points.
• Off of Fed funds options, the odds of no change are 10%, odds of a 25 basis point cut are 70%, and the odds of a 50 basis point cut are 20%.
• Since the last meeting, fed funds have averaged 3 basis points over the target.
• The discount window moves aided PR efforts, but never amounted to much.
• As measured by TIPS, five year forward five year inflation has fallen since the last meeting, but has been slowly rising over the past five years.

There’s my data, now for the analysis.  Credit conditions have loosened, but monetary conditions aren’t loose.  Banks have been willing to expand their balance sheets, I believe partly due to the Fed loosening capital requirements, e.g.,  lending to securities affiliates.  Also, with the bigger banks, the Federal Reserve is talking tough, but not playing tough in bank examinations, because they can’t allow credit to contract that much, or their loosening policy will have little impact.  The smaller banks, and banks where mortgage lending could have a big impact are undergoing sharper examinations.  Part of that looseness is canceled out by the tightness in the Euro-dollar markets; the big banks are less than fully willing to trust each other’s balance sheets.

My opinion: The FOMC will loosen 25 basis points on 10/31, and will continue to express worries over economic growth.  Though inflation is a growing threat, the FOMC will downplay that.  There will be a lot of trading noise around the news, but after the dust clears, stocks and bonds won’t have done much, and the yield curve will be a little wider.  TIPS should outperform inflation un-protected bonds.  The dollar will weaken to the degree that the FOMC hints that they aren’t done.