Markets & Finance

The Fed: A Tilt Toward the Tighter Side?


As Bernanke begins his second full year as Fed chief, a steady policy stance is expected, though a hike is possible by September

Ben Bernanke was certainly busy as he kicked off his first year as Federal Reserve chairman, with the central bank raising rates at the first three policy meetings over which he presided. But as the Fed chief starts the second full year of his tenure, the central bank remains locked in a holding pattern, having taken no action on rates at the last four meetings. The Jan. 30-31 meeting of the Federal Open Market Committee, the Fed's rate-setting arm, should extend the trend.

The FOMC is widely expected to maintain a steady policy stance with a 5.25% Fed funds rate target, while continuing with its bias toward firmer rates. Recent data reflecting a more encouraging growth outlook will give the Fed confidence in its expectation for the economy. But price measures—including the December readings for the producer price index (PPI) and consumer price index (CPI)—remain elevated above their comfort zone, suggesting no change to their inflation vigilance.

The Fed's policy statement is likely to note improvement in the economy and stabilization in housing, in contrast to December's policy statement that growth had slowed, in part due to "substantial cooling" in housing.

How They Line Up

Policymakers will get a chance to eyeball the latest data on growth as the Jan. 31 session gets underway. That morning, the government's advanced reading of fourth-quarter gross domestic product (GDP) is scheduled for release. We at Action Economics expect a 2.7% growth clip, which is modestly below economists' median forecast of 3.0%. The GDP report will be an important update not only for the fourth quarter, but also for the trajectory as we enter the first quarter.

Of interest will be whether any of the new FOMC voters, including the hawkish St. Louis Fed President William Poole (he also voted at the October and December meetings, filling in for the retired Atlanta Fed chief Jack Guynn), Chicago Fed's Michael Moskow (hawk), Kansas City Fed's Thomas Hoenig (moderate hawk), and Boston Fed's Cathy Minehan (moderate), take over the dissenting position of the hawkish Atlanta Fed President Jeffrey Lacker, who is not a voting member this year. Lacker has cast the lone dissenting vote against the Fed's "steady-as-she-goes" policy in each of the last two FOMC meetings.

Nascent Worries

Note that both Poole and Hoenig have dissented against easier policy in the past. Hoenig has lost some of his hawkish feathers, however, and isn't likely to take that road currently. Poole did not join Lacker late last year, but could be a good candidate to take up that post currently. Moskow may also cast a dissenting vote, though he has never done so in the past, and may not feel compelled to do so now.

For its part, the bond market has completely reined in its earlier expectations of any near-term easings by the central bank. Fed funds futures, a trading vehicle used by market pros to bet on the future direction of interest rates, indicate that the market expects a steady Fed stance through the second quarter, with some nascent fears a hike might be the next move.

We still look for the Fed to remain sidelined until fall, though a hike is possible by September. We also expect the Fed to remain "data dependent", gauging the risks to growth and inflation on a case-by-case basis. The next big release: The employment report for January on Feb. 2. Stay tuned.

Rupert is managing director of global fixed income analysis for Action Economics.

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