Around the Street
Sizing Up the Fed's Next Move
Will the Federal Reserve stick to its policy of ultra-low interest rates "for the foreseeable future" at its Sept. 22-23 policy meeting? Or could Ben Bernanke & Co. open the door ever so slightly to the possibility of higher interest rates if the U.S. economic recovery gains traction? BusinessWeek compiled comments from Wall Street economists and strategists on interest rates, inflation, and the direction of the U.S. dollar on Sept. 16.
The FOMC meets next week on [Sept. 22-23]. There's growing talk that policymakers might finally articulate more of an exit strategy, with some in the market even talking about a tightening. While we believe worries of an actual rate hike as soon as [Sept. 23] are premature, there are a number of factors recently that suggest a definite shift out of the über-accommodative mode should be in the works…. Though Bernanke's comment [on Sept. 15] that the recession is likely over was cherry-picked by economy bulls—he wasn't too optimistic on the labor market and said it's still going to feel like a "very weak economy" for a while—it nevertheless reflects an ever improving outlook at the Fed.
Additionally, most of the real sector data continue to outperform expectations, such as [the Sept. 16 release of August] production data and the [Sept. 15] retail sales report, and point to positive GDP growth beginning this quarter.
Perhaps most importantly, some of the more hawkish regional presidents are current FOMC voters, namely Richmond's [Jeffrey] Lacker and Atlanta's [Dennis] Lockhart. The Chicago Fed's [Charles] Evans is also more inclined to the hawkish side of the spectrum. New York Fed's [William] Dudley hasn't really moved away from a very centrist position, aligned with the consensus, while the San Francisco Fed's [Janet] Yellen is one of the most ardent doves. We wouldn't be surprised to see a dissent or two from one of the three hawks above, if the consensus is for the status quo.
Edward McKelvey, Goldman Sachs (GS)
A new paper by John Williams of the San Francisco Fed provides new support for the view that we have embraced on Fed policy—namely that the zero lower bound on the federal funds rate represents a significant constraint on monetary policy, which in turn will keep growth slow and postpone the rate hikes that most forecasters now anticipate for 2010. In simulations of how a negative funds rate would likely affect inflation and the unemployment rate, Williams presents a strong case that the Fed would come closer to achieving desired objectives on both counts. He also suggests that the 2% level that most central banks use for inflation targets could be too low if the equilibrium real short rate has fallen or if shocks to the system have become more volatile or persistent.
Win Thin, Brown Brothers Harriman
Dollar bears always bring up the U.S. current account deficit as one of the primary factors behind their bearish outlook. There are flaws in using the current account deficit as part of the bearish dollar story, but even if we take that at face value, we note that the current account gap is expected to narrow to 2.9% of GDP this year vs. 4.9% in 2008 and about 6% of GDP in both 2005 and 2006. That trend is unmistakably dollar positive, and yet the dollar has been largely weaker over that period and so other factors are clearly at work.
The market is looking for a slight widening of the current account gap in 2010 to 3.2% of GDP, which to us is hardly worrisome. But look for the dollar bears to start making noise about the widening U.S. gap again, as a pickup in the U.S. economy is likely to lead to increased imports. Again, we would advise against using such a simplistic argument as part of a dollar bear story.