Friday, 1 July 2005

Fed raises rate as signs of softness return

As widely expected, the FOMC decided to raise the target federal funds rate by 25 basis points to 3.25 percent yesterday. The rate hike came despite the fact that other indicators out of the US yesterday were showing signs of a soft patch.

[T]he National Association of Purchasing Management-Chicago business barometer slipped to 53.6 in June from 54.1, meaning that businesses grew a bit less than expected...

The Commerce Department said personal income in May increased 0.2 percent, just below Wall Street forecasts for a 0.3 percent gain. That followed a 0.6 percent advance in April and was the weakest reading since January. Consumer spending was flat compared with forecasts for an advance of 0.1 percent after a 0.6 percent increase in April. The price index for consumer expenditure, a measure of inflation favored by Fed Chairman Alan Greenspan, was also unchanged after rising 0.4 percent in April.

Jobs numbers, however, looked better.

The number of Americans seeking initial jobless compensation unexpectedly fell by 6,000 last week to the lowest in more than two months, the Labor Department said. First-time claims for state unemployment insurance, an early reading on the resilience of the job market, fell for the second straight week, slipping to 310,000 in the week ended June 25 from a revised 316,000 in the previous week... The four-week moving average also fell for a second consecutive week, dropping to 323,500 from 333,750.

Tim Duy, for one, was somewhat surprised by the optimistic tone of the FOMC statement.

The thinking in the FOMC remains more optimistic on growth compared to the view of many market participants. FOMC members do not believe they have entered the ninth inning. The FOMC intends to continue raising rates, and likely do not have an end target in mind.

Kash at Angry Bear pointed out that the real federal funds rate: still far, far short of where the real federal funds rate typically is during periods of reasonably good economic growth... If one believes in an exogenously 'neutral' real federal funds rate...such a neutral fed funds rate is probably somewhere in the neighborhood of 3-4%.

But I have my doubts...because I wonder if relative interest rates aren't sometimes just as important as absolute levels of interest ... So while today's interest rates are indeed low in an absolute sense, I worry that raising interest rates will still chill economic growth from its current level, which is only mediocre to begin with.

No doubt, he is worried that the US would follow in the footsteps of the UK, which, as Michael Shedlock (Mish) opined, may be headed for recession, based on the downwardly-revised first quarter GDP, hard-pressed retailers, declining consumer confidence and a worsening current account deficit. Mish pointed out, though, that these, together with other global economic conditions, might actually be good for the US dollar.

US dollar bears need ponder this: The UK has now recorded a current account deficit for every quarter since the third quarter of 1998. The EU is in shambles, Chinese banks are deep in trouble, and the UK does not exactly seem to be such a pillar of strength either... [T]here is not another currency worth buying. Of course this bodes well for gold over the long haul. One of the reasons gold has begun to rally in other currencies is simply because there are few other places to hide.

Well, rising interest rates followed by a rising US dollar and weakening economy is not exactly an illogical sequence of events. It would even account for the low long-term rate "conundrum". Whether that's the scenario that policy-makers have in mind is another matter.

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