Monetary Policy

My policy indicators may have all turned the corner in favor of having the Federal Reserve
raise interest rates, but the upward direction of several of them may have to continue on
for months before the evidence becomes more nearly conclusive. Specifically, producer
operating rates have recovered sharply, but are still on the low side, while short term
business credit demand, although perhaps coming off a cyclical low, is still very depressed.
If the economic recovery proceeds a little faster this year and more steadily, the traditional
case for raising short rates would be in place by very late this year.

My shorter term business credit supply / demand pressure gauge is very weak when it falls
below a reading of -7.0. In the wake of the 2000 - 2001 economic downturn, the gauge dropped
to a -9.5 in 2003 as the credit excesses of the telecom / tech / dot.com bubble were washed
out. The gauge fell to a staggering -18.5 in early 2010 following the near economic depression.
The gauge has recovered to a still very weak -8.9 and could rise to equilibrium at 0.0 by
the middle of this year. It is not for nothing that the Fed cut the FF target rate to between 0.0 -
0.25%.

One factor you can monitor here is the relationship between banking system holdings
of Treasuries and Agencies and the level of commercial and industrial loans. When recession
strikes, banks build liquidity by buying short Treasuries and letting C&I loans run off. On the
eve of the onset of economic free fall in mid 2008, the banks held $1.2 tril. in Treasuries
against $1.6 tril. in C&I loans. Now, they hold over $1.6 tril. in Treasuries and a little over
$1.2 tril in C&I. The Fed watches this balance carefully, and when the economy is
recovering and the banks are taking on new C&I and letting Treasuries run off, They will take
careful note of that (banking system data).

You should also keep an eye on certain market shorter term interest rates as the year progresses
to see if market players are anticipating the Fed will be raising rates. You can watch 270 day
commercial paper, 1 and 2 year Treasury yields and 12 month Libor. These indicators are
far from infallible as guides to policy, but are well worth watching.