Most everyone expects the Fed will leave the Fed Funds
Rate unchanged at 5.25% when the FOMC winds up a two day
meeting tomorrow. This time, the fundamentals the Fed tracks
most closely line up to support leaving the FFR% as is. I
doubt the staff at the Fed was happy to see the Board go
for the pause as early as It did, but the fundamentals have
followed.
The breadth of short rate sensitive economic growth experienced
a cycle peak in mid - 2004, just as the Fed elected to raise rates.
The deterioration of breadth -- number of industrial sectors
encountering slower growth -- has been more gradual than in prior
cycles when the Fed was raising rates. This large component of
the cyclical economy is now much closer to levels that would signal
the Fed it should reduce the FFR%. However, unless there is a sudden
steepening of the slowdown, the Fed may feel no compulsion to ease up
soon.
Looking more broadly, the Fed must contend with two factors. It
needs to make a guesstimate whether the economic effects of a
protracted but gradual round of tightening have been fully
reflected in the economy, and it also needs to study to what
extent the sharp recent deceleration of inflation may engender
growth via a boost to real incomes and confidence. Finally,
since available data indicate continued very slow growth of US
productive capacity, the Fed needs to factor in a longer range
inflationary bias to the economy.
The growth of monetary liquidity has all but halted since the
summer. The Fed has tightened on the liquidity front to counter
the acceleration in growth of credit driven liquidity reflecting
strong bank lending expansion. All well and good, so long as the
central bank remembers to reverse course if and when credit growth
slows.
The stock market is slightly less overbought in the
very short run, but is also now overbought on my six to thirteen
week indicators. Moreover the measures of sentiment I watch have
deteriorated as well. The trend is up but it is well recognized.
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