Will They or Won’t They ? Predicting the Fed

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While challenges to the Fed’s full employment mandate are fairly clear by way of renewed disappointment to GDP (1.5% in Q2) and sub-100k monthly employment growth, it is often suggested that any policy response by the Fed may be constrained by the fact that its price stability mandate is not itself being disappointed.  Inflation risk, it is surmised, is not what it was when QE2 was introduced and the Fed must therefore wait it out to see if further inflation downsides — particularly deflation risks — emerge.  This isn’t really true on two counts: one is that there are already strong parallels between inflation readings now versus when QE2 was factored into market expectations; the other is that the Fed could well decide that inflation is well behaved enough, allowing it to focus upon deeper disappointments to its full employment mandate.  In other words, sharp disappointment on one half of its dual mandate and less so on the other may well prove to be sufficient to motivate a move toward providing additional stimulus. 

To put it layman’s terms, the Fed’s have certain responsibilities and can take only limited action to help the economy. Employment and Inflation are the prime responsibility of the Fed. The Fed can stimulate these or reduce these through monetary policy such as interest rate cuts or increases or monetary stimulus as we have seen in the past few years.

The Fed cannot slow or stop the housing market just because prices are climbing, and cannot stimulate the housing market because it is slow, this is for other agencies. Now if a climb in housing prices is causing inflation, then the Feds can intervene.Everything the Fed, does, says or evaluates remains with this viewpoint.

So simply wanting to stimulate the economy, because it seems stalled, is not a job of the Fed, also there is a fine line between stimulating the economy and causing inflation.

Mr. Bernanke and partners do not have an easy job, their actions are limited and their reasoning for action is limited.

On July 31st and August 1, the FOMC, The Federal Open Market Committee, will hold their two day meeting. There is no planned statement for this meeting. At present bookmarkers are giving 40% odds that the FOMC offer some sort of monetary stimulus at this meeting. The odds increase to over 60% for the September meeting.

In an election year, things also have a problem as the wrong or excessive action can be interpreted to be favoring a candidate, and let’s face it with the Obama Administration is in a tough fight and the economy and jobs will be the deciding factor. If there isn’t a glimmer of hope a possibility seen at the end of the road, voters are going to say that Obama hasn’t helped things in 4 years so why give him another chance. When voters are happy or see some light at the end of the tunnel, they do not want to upset the apple cart, which would be good for an incumbent. The Federal Reserve is not supposed to have any political affiliation, and is not a politically controlled organization.

The U.S. inflation picture is currently similar to the conditions that existed when Federal Reserve Chairman Ben Bernanke strongly hinted at QE2 at the Jackson Hole, Wyoming central bankers’ conference in August 2010.  This gives the Fed the last piece of the puzzle to justify introducing additional stimulus including QE3 to which we attach 40% odds at the upcoming FOMC meeting and 65% odds at the September meeting.

With a disappointing Nonfarm payroll report earlier this month, and poor unemployment numbers all month long combined with a lackluster GDP release on Friday, the Feds now have the everything in line to make a decision, except we do not know at what point the Fed’s will view the economy in need of stimulus.

The question is will they or won’t they ? 

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About: FX Empire Analyst - Barry Norman

Barry produces a private Daily Market Review newsletter that is distributed around the globe to over 25,000 subscribers and recently published a book on Options Trading that is available from amazon.com

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