Looking Backwards at the FOMC Meeting

I posted three times on the Fed today over at RealMoney.com.  Here are two of the more important posts:


David Merkel
Since the Last FOMC Meeting
10/31/2007 12:28 PM EDT
  • Canadian dollar up 7%
  • Euro up 5%
  • Swiss franc up 3%
  • Yen flat
  • Long U.S. Treasury bond up a few ticks in price ~0.1%
  • 3-5 year Treasuries up half a buck in price ~0.5
  • Yields on the short end fall 0.25%
  • U.S. dollar LIBOR falls 70 basis points, and the TED spread falls 47 points to 104 basis points.
  • The volatility index falls 25%, but all of that occurred on the first day
  • Five-year forward five-year inflation as implied by TIPS, has fallen 20 basis points
  • The S&P 500 returns 4.5%
  • Here’s the summary: Systemic risk has declined but is still an issue. The U.S. dollar is weak, because projections of future FOMC policy point to lower short rates, when the rest of the world isn’t going that way. Note the declines against the non-carry-trade currencies. Market stability has brought the carry trade back.

    The FOMC will likely cut 25 basis points today and leave a “growth risk” assessment in place. That’s what the market is expecting; anything different from that will drive any market surprise. At 50 basis points, the dollar tanks, implied inflation rises, the yield curve steepens and the stock market rallies, at least temporarily. With no cut, the dollar rises, implied inflation falls, the yield curve flattens and the stock market falls, at least temporarily.

    Well, let’s watch the furor at 2:15. If we get 25 bp, there should be noise, but not much movement to the close.

    Position: none — happy Reformation Day!


  • David Merkel
    Correction
    10/31/2007 3:34 PM EDT

    The FOMC vote was not unanimous. Governor Hoenig felt no change was needed. So what has happened so far?

  • Yield curve steepens
  • Equity market rallies
  • Volatility index falls
  • Dollar falls
  • Expectations of future Fed funds moves declines — fewer cuts anticipated
  • Long bonds fall in price, rise in yield
  • TIPS fall a little less, show a touch more in inflation expectations
  • Gold and many commodities rise; oil stays flattish.
  • All in all, a market that fears inflation to a degree, but is not worried that much about growth.

    Position: none

    Okay, I got the growth risk assessment wrong, but largely, my analysis of FOMC action has been on target.  As for my post yesterday that got a bit of play over the web, I would just like to clarify a few things.  First, my view does not imply permanent easing of Fed policy.  Quite the contrary, I am an advocate of a flattish yield curve under ordinary circumstances, because it restrains speculation, and tends to preserve a sound currency.  That said, if one has to deviate from my baseline policy, don’t waste time getting to your policy goal, because slow adjustments merely put off the time when the cumulative adjustment is enough to matter.

    As for the inability of anyone to call turning points: true enough, unless you’re ECRI — maybe we can outsource monetary policy to them.  But the idea of having a central bank presumes their ability to spot turning points, and take action.  If they can’t do that, let’s simplify the system, and move back to a currency board or a gold standard.  Let’s take monetary policy out of the hands of politicians, and those whom they appoint, and put it back in the hands of the free market, if they can’t pick turning points.

    As for the Federal Reserve being affected by politicians, perhaps Volcker was an exception, but during the Carter and Nixon years, the White House successfully attempted to influence policy.  Greenspan admits to being influenced on policy decisions by the White House as well.  If we need more proof, look at the prior loosening cycle, where the rates went far lower, and stayed abnormally low far longer than a policymaker following the Taylor Rule would have done.

    PS — I am a fan of Dr. Jeff Miller, though we likely disagree on issues like this.  His addition to the commentary over at RealMoney.com is a real plus for the site.