No Rest for the Fed


By Michael Wallace and Kim Rupert If there are any surprises in the outcome of the June 29-30 Federal Reserve policy meeting, they likely won't come on the monetary-policy end. We at Action Economics believe Alan Greenspan & Co. will boost the benchmark Fed funds target rate by a quarter percentage point, to 3.25%, as pretty much everyone expects.

The real focus for the markets will be the FOMC's post-meeting policy statement, scheduled for release at 2:15 p.m. ET on June 30. And that's where some on Wall Street might be disappointed. Bond prices -- and yields -- appear to be anticipating that the Fed might signal that it's ready to hit the pause button for rate hikes after its June 30 tightening. However, we don't expect any major changes to the Fed's now-standard template: that policy remains "accommodative," and that accommodation can be removed at a pace likely to be "measured" -- signaling no near-term pause in the pace of rate hikes.

All around us, market and media commentary on that policy statement continues to center on possible signals of a pause. We, on the other hand, see little reason for policymakers to hint a shift is coming any time soon. Indeed, amid recent solid economic data, the risk is that policymakers are more upbeat on growth. And even though the May inflation data were mild, the surge in oil to the $60-a-barrel neighborhood could keep the Fed cautious on the inflation front.

PASSING SOFTNESS. Still, with the funds rate now at 3% -- two percentage points above last year's low -- we suspect that the central bank is getting sufficiently close to the point where it might start removing much of the canned language from the policy statement. But we doubt that any such language change would signal a pause in the near future.

Indeed, the sentiment in the statement continues to shift to the hawks. We believe the market is underestimating the Fed and expect the FOMC is on course for quarter point rate hikes at each meeting until at least 4.0% has been hit, which would be in November.

For the June 30 statement, we expect policymakers to upgrade their assessment of the economy from the May release, given the recent run of economic reports showing that any economic "soft patch" was transitory. We suspect the FOMC is even less concerned with the current "soft patch" than it was with 2004's similar blip, and is increasingly concerned with the potential for inflation.

INFLATION PATROL. If there is a wild card this time around, it may be in the central bank's inflation outlook.

Indeed, two key changes in the May statement from the March release indicated that policymakers were already taking a much more hawkish tone on inflation. Left out in May was the March statement that "the rise in energy prices...has not notably fed through to core consumer prices." Initially, the Fed's May statement also left out "longer-term inflation expectations remain well contained," although the central bank later issued a correction stating it was inadvertently deleted.

It's uncertain whether policymakers will change their outlook on prices this time around, as tame consumer and producer price reports for May are ancient history with oil at around $60 a barrel. Wallace is global market strategist, and Rupert managing director of global fixed income analysis, for Action Economics


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