Fed drops its inflation bias? Not so fast. 22 Mar 07

Key News
• Japan's Trade Surplus Unexpectedly Widens 7.7% (Bloomberg)
• Australian Dollar May Extend Rally as Options Traders Increasingly Bullish (Bloomberg)

• Key Reports Due (WSJ):
8:30a.m. Initial Jobless Claims. Expected: +2K. Previous: -12K.
10:00a.m. DJ-BTMU Business Barometer For Mar 10. Previous: -0.2%.
10:00a.m. Feb Conf Board Leading Economic Indicators. Expected: -0.3%. Previous: +0.1%.


"The longer I live the more I see that I am never wrong about anything, and that all the pains that I have so humbly taken to verify my notions have only wasted my time."

- George Bernard Shaw (1856-1950)

FX Trading – Fed drops its inflation bias?  Not so fast.

Well, consensus tells us to expect a rate cut from the Federal Reserve in the coming months.  At least that’s how we took it from the way the markets reacted to the Fed’s comments in this week’s FOMC meeting that wrapped-up yesterday.  The dollar quickly surrendered early gains and continued falling after the announcement.  Treasuries rallied and corresponding yields turned lower. 

It’s interesting to us how just mincing a few words or phrases totally changed the way the Fed’s comments were interpreted. 

“Readings on core inflation have been somewhat elevated.”

“In these circumstances, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected.

Each of these pieces was added and both reflected an increased focus on inflation.  What was taken out was the reference to “additional firming” of rates as needed.  But after all, when it comes down to it, there really doesn’t seem to have been much of a policy shift from the previous meeting.  If anything they sounded a bit “tighter” to us than what was perceived by the masses. 

The thing to do now is to start looking ahead, find out what idle Fed policy means to the U.S. housing market, the U.S dollar, and the U.S. consumer. 

Ha.  We wish it were as easy as it sounds.


A lot depends on any new evidence that the housing bust isn’t over; or if there’s a legitimate threat of a spillover from it.  There’s no doubt some people would like to see the Fed come to the rescue with lower interest rates.  But the Fed needs to make it seem as if they’re acting prudently, evenly balancing growth concerns with inflation concerns.


More downside to the housing collapse could make a serious difference in their ability to spend.  Choking off the consumer chokes of the mainstay of U.S. growth.  It’s a nasty downward spiral after that.  Many believe the Fed simply can’t let that happen.  And maybe that’s why the markets behaved the way they did yesterday not because of what the Fed will do, but instead what we hope they will do.


If it really falls out of bed (like so many are calling for it to do), where does the Fed go from there?  At that point any response in the form of a rate hike may be too late.  Imports become extremely expensive.  Those costs are eventually passed on to the consumer and inflation really picks up.  And that’s not to mention what emergency hikes would do to vulnerable housing and subprime markets. 

It seems to us that the dollar might have some more downside before people start to understand that it’s not a one way street and a rate cut isn’t the Fed’s only option.  It may take a bold move to finally escape this seesaw of pain (as our good friend and devoted natural resource analyst Sean Brodrick would say.) 

Bottom line: the Fed has a tough job, one that we’re not envious of. 

Good luck out there.

John Ross Crooks III

Average rating
(0 votes)