Federal Reserve Chatter – Looking Forward to tomorrow's Economic Data

By: David_Urban

Monday was an interesting day as Federal Reserve officials gave speeches which were dissected by the market for clues ahead of next weeks FOMC meeting.

Janet Yellen, president of the San Francisco Federal Reserve and one of the two governors who asked for a discount rate decrease, cited risks to consumer spending from the subprime fallout and downward pressure but also cautioned against a bailout.

Dallas Fed President Richard Fisher remarked that the consumer appeared to be weathering the financial storm and that his contacts relayed an upbeat assessment.

Dennis Lockhart from Atlanta backed off remarks that the economy was not showing signs of weakness to stating that Friday's unemployment data needed to be taken in context with other economic data and not looked at in a vacuum.

Philadelphia Fed President Charles Plosser, in an interview last weekend, echoed views that the decline in employment did not merit lowering interest rates by itself and the market should be careful not to overweight one piece of information.

Fed Governor Frederic Mishkin commented that economic uncertainty may cause a pullback in business and consumer spending.

The market has priced in a 25 basis point cut in September and is looking for more. The talking heads are beginning to fall over each other to proclaim 50 and 75 basis point cuts. After careful thought, the market appears to be acting similar to 1998 after the LCTM collapse rather than before the 1987 market collapse. Earlier this year it appeared as though the market was acting in a similar manner to 1987 as LBO's were the flavor of the day. The market was looking for a rate cut despite strong growth and got sideswiped by a rate increase instead. As the year went on, during our stagflation stage, I believed the Federal Reserve was going to lower rates over the summer in order to stimulate the economy but now it appears as though the consumer and underlying economy are weathering the storm just fine. This indicates to me the rate cut cycle will be less than people are anticipating and rates will once again rise sooner than expected.

Bernanke has been taking a surgical approach to repairing the damage in the commercial paper and asset-backed security markets using all of the tools at his disposal. He knows that a cut in the Fed Funds rate will be more psychological than anything else. A 25 or 50 basis point cut will not save the person whose mortgage is resetting to a much higher rate in the next six to twelve months.

Personally, I am on the fence with regard to a cut. On one hand, the market is acting like an addict looking for a fix and believes if it gets a rate cut liquidity will magically appear and restore confidence in the system. The problem with cutting rates is the Federal Reserve risks losing credibility in the inflation fight and will be seen as bailing out Wall Street for the mistakes they made.

I believe that one of two situations will occur. The first is that the Fed will cut rates by 25 basis points and issue a strong statement not indicating an easing policy but a neutral or tight policy. The other situation is that the Fed will not cut rates but issue a statement indicating an easing policy.

Tomorrow, all eyes will be focused on the retail sales, industrial production, capacity utilization, consumer sentiment, and business inventory figures. Needless to say, it will be an interesting day.

By David Urban

http://blog.myspace.com/global112

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