Give The People What They Want

The Fed announced that it is easing 25 basis points (Fed Funds and Discount rate). The Fed expressed concern over inflation and stated that it believes that stimulus it has already injected into the economy will promote modest growth. However, the financial markets latched on to this:

"Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.

Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization."

It ignored the fact that the Fed left out the "downside risks remain" from the previous statement. Although the Fed may not be stating that it is pausing, it is hinting that it is getting near the end of its easing cycle.

To be fair to the market, the Fed's statement has me concerned as well. When it stated:

"Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization."

it made me think the Fed doesn't understand why some commodity prices (food and oil) are higher (speculation and the weak dollar, not increased demand). However, a wave of sanity came over me and I realized, the Fed knows what is going on.

If it knows the true reasons why food and energy prices are higher, why is it playing dumb? The answer is the dollar. The Fed does not determine dollar policy. That is the domain of the treasury and, by extension, the President. Besides, the Fed knows that the majority of the increased demand comes not from the U.S., but from overseas.

Does this mean that the Fed is on the correct course? I hope so, but an increasing number of economists are joining my camp that the Fed should pause now. With American families having difficulty managing monthly budgets, rationing of various food stuffs and the Canadian government paying farmers to kill hogs rather than feed them to free up food crops, the current situation cannot exist forever. Look for oil below $100, a Fed pause and the long bind at 4.75 by the end of the third quarter. The interim period will be most interesting, however.