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John Adams Blog

The blog of The Antient and Honourable John Adams Society, Minnesota's Conservative Debating Society www.johnadamssociety.org

Tuesday, August 08, 2006

Interest Rate Pause?

Is Bernanke finally going to listen to little ol' me and pause the 2-year string of interest rate hikes?

A story in the Star Tribune today opines, "there is still some uncertainty over the Fed's next move because while the economy has been slowing, inflation pressures have been rising."

This scenario combined with continued interest rate hikes would almost certainly return us to the stagflation of the late 'seventies.

The Strib goes on, "The Fed's favorite inflation gauge, which is tied to consumer spending, showed core inflation — excluding energy and food — rose by 2.4 percent in the 12 months ending in June, the fastest clip in 11 years, and above the Fed's comfort zone of 1 percent to 2 percent."

This is a simplistic test. You CAN'T remove energy from consumer spending. Oil prices are built into all tangible goods. Transportation of products is not an insignificant portion of the consumer price, and the general cost of doing business in almost all circumstances is influenced, if even to a minute degree, by energy prices.

Further, the Fed does not give its tightening or loosening measures enough time to work before making its next decision. I predict that the Fed will actually need to ratchet the rate down in the next six months.

Holding my breath . . .

Blogger Scribbler de Stebbing said...

. . . And then he had to ruin it by saying "some inflation risks remain," letting all the air out of the stock market. So let's start drilling for oil, eh? Everyone else is doing it.

Ah well, let's take the pause for now. Anyone taking odds on seeing a 1/4 point rate reduction sometime in the next six months?

2:05 PM, August 08, 2006  
Blogger Harsh Pencil said...


There is a market for these bets.
This market is still putting a 56% chance that rates will be increased one more time by the end of the year.

Via Bloomberg,

Futures Traders Pare Bets on Rate Increase by End of the Year

Aug. 8 (Bloomberg) -- Futures traders pared bets that the Federal Reserve will boost its overnight lending rate between banks by the end of this year after the central bank ended its streak of 17 consecutive increases.

The yield on the federal funds futures contract for December fell 2 basis points, or 0.02 percentage point, to 5.34 percent at the Chicago Board of Trade. It suggests a 56 percent chance of an increase to 5.5 percent from 5.25 percent by the end of the year, down from 68 percent yesterday.

In their toughest decision since Chairman Ben S. Bernanke took the Fed's helm in February, central bankers are counting on economic growth slowing enough to damp a pickup in prices. If they make the wrong call, policy makers may have to clamp down harder in coming months and risk smothering the expansion.

St. Louis Fed President William Poole said last week he was ``50-50'' about whether to keep lifting borrowing costs.

The Fed on June 29 lifted the benchmark interest rate by a quarter-percentage point to 5.25 percent, the highest since January 2001.

The decision today represented the first time in 18 meetings of the central bank's Federal Open Markets Committee since June 2004 that the rate was not increased. The next meetings of the FOMC, which votes on the rate moves, are on Sept. 20, Oct. 25 and Dec. 12.

Futures are agreements to buy or sell assets at a set date and price. Contracts on interest rates are settled in cash. Fed funds futures settle at the fed funds effective rate, which is the average of all overnight rates for the month.

An increase in the Fed's target to 5.5 percent by December would raise the average overnight rate in that month to 5.411 percent. The rate on the fed funds futures contract is derived by subtracting the contract's price from 100.

2:53 PM, August 08, 2006  
Blogger Scribbler de Stebbing said...

56% isn't an overwhelming margin, though I imagine few think there will be an actual rate cut. I'm still going out on that limb, even if it is wishful thinking.

Rationally, another hike would hurt the economy further. Much of what was fueling the economic growth, in addition to capital gains tax cuts, were new housing starts. Those have tapered off as interest rates have climbed, obviously. I understand that the rationale for increasing interest rates is to curb the appeal of debt, but mortgage debt isn't such bad debt to have. Consider that renters were buying homes and that all boats were being lifted by that rising tide.

Again, I say a simple look at consumer price increases, energy and food aside, is not a sufficient indicator of consumer demand as energy prices have been artificially raising prices of all goods.

Without genuine economic growth and a decrease in unemployment, further interest rate increases will do harm to an economy that wants to take off, and I believe a small cut is warranted.

Consider too that baby boomers are still investing in the stock market, and that is a more worthy place for their money than in bonds, as their investment in the market will provide the capital to increase employment both directly and through trickle-down economics.

I don't pretend to understand this more than you, Pencil, but I am questioning the automatic inflation-necessitates-rate increase-philosophy. Did it work in the Seventies?

The Fed needs to be more conservative and wait longer between manipulations before further tinkering is warranted.

4:40 PM, August 08, 2006  

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