Getting a Fix on the Fed

What Wall Street experts have to say about the upcoming FOMC meeting, economic data, bank lending, and the stock market on Nov. 2

By BW Staff

BusinessWeek compiled comments from Wall Street economists and analysts on key economic and financial market topics on Nov. 2:

Edward McKelvey, Goldman Sachs (GS)

The 3.5% annualized growth rate reported provisionally last week for third-quarter real GDP was a stronger-than-expected exit from recession. It featured rebounds in consumer spending and residential investment, while business fixed investment and state and local spending fell less than we had anticipated. Although precise estimates are not possible, our analysis of the distribution of this growth suggests a heavy contribution from federal fiscal stimulus. In addition to the widely reported impact of the cash-for-clunkers program, we see more general evidence of a fiscal effect from income support to households and aid to states and localities. Unfortunately from this perspective, the last quarter also marked the peak of the impact of fiscal stimulus on growth, at least as we evaluate current law.

To those who are surprised by this statement, we note that: (1) the bulk of last February's package was in tax cuts, income support, and state and local aid, which took effect quickly, rather than in slow-starting investment projects; (2) the effect of stimulus on growth depends on the changes in spending it induces rather than on the level of spending itself. As the impact of stimulus fades, the onus will be on job creation to sustain growth. In the absence of that, policymakers will almost surely extend some of these programs. In fact, the first of these efforts is already under way as several expire before yearend.

We do not expect major changes in the FOMC statement [on Nov. 4]. In particular, while officials are reportedly thinking about how they might eventually modify the language regarding future interest rates, a change at this meeting is quite unlikely.

Ethan Harris, Bank of America Merrill Lynch

With the economy turning up, the markets are on high alert for rate hikes from the Fed. Every time an FOMC hawk says that "the Fed will need to raise rates sooner rather than later" or Fed staff talks to the Street about technical issues around its exit strategy, the chattering class gets excited. The latest "Fed fake" is a newswire story about Michael Woodford, a member of the Monetary Policy Advisory Panel for the Federal Reserve Bank of New York. Asked if the Fed will soon drop its promise to keep rates low for an "extended period," he responded: "I could imagine them dropping the language." He went on to explain that "the problem with this kind of language is that it's perceived as making a promise about future interest rates independently of what happens in the meantime." Is this close adviser to the Fed signaling a change in the Fed directive this week?

The answer in our view is almost certainly "no." It is important to understand how the Bernanke Fed signals major policy changes. The signals don't come from Reserve Bank presidents or advisers; they come from either the overall committee—in the form of the official statements—or from the core of the committee—that means Bernanke, [Fed Vice-Chairman Donald] Kohn, and to a lesser extent New York Fed President [William] Dudley. The Advisory Panel plays a very secondary role in thinking at the Fed. When I was at the Federal Reserve Bank of New York, we had to brief the advisory group before they talked so they were up to speed on the data. Moreover, the directive already includes the contingent language Woodford recommends. It says: "economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period." Perhaps the Fed could expand this and say: with considerable economic slack and a likely moderate recovery, economic conditions are likely to warrant…

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