RealMoney Silver - Two Major FOMC Themes

Two Major FOMC Themes
By Tony Crescenzi
RealMoney.com Contributor
9/18/2007 3:07 PM EDT

There are two major themes within the FOMC statement that signal the Fed's expected path in the period ahead:

The Fed considers its action pre-emptive, and in light of inflation risks, additional large interest rate cuts should not be expected.
Although the magnitude of rate cuts is likely to be smaller going forward, the Fed left the door open for more cuts.

On the first point, the Fed's pre-emptive tone is apparent in the use of the word "forestall" to describe the rate cuts' intended effect on the broader economy:

Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

The notion that the Fed wanted to guide expectations lower for future cuts is implied by the re-insertion of inflation into the FOMC statement (inflation concerns were not expressed when the Fed cut the discount rate on Aug. 17):

Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

With respect to the second point, the Fed left the door open to future cuts. It did so in two ways. The first was accomplished in what wasn't said. Unlike past FOMC statements, the current one does not contain a forecast for continued moderate growth, only an intention, expressed in what the rate cut was designed to do: "promote moderate growth."

The second way the Fed signaled that the door remained open was in the standard phrase "act as needed":

The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Stylistically, it is worth noting that the Fed lowered expectations for the possibility of a 50 basis point rate cut in the several speeches delivered following the release of August employment statistics. As I have been speculating, the only reason to have guided the markets toward a 25 basis point cut when a 50 basis point cut was still on the table was to retain the element of surprise, a potent tool -- and a crafty move by the Federal Reserve.

Notable also is the 10-0 vote, a vote almost certainly unrepresentative of the actual sentiment toward 50 basis points, a view that is likely to become more evident in the weeks ahead.

A negative angle on today's action is that it could create unreasonable expectations about future interest rate cuts, requiring active guidance from the Federal Reserve regarding the likely path of monetary policy.

Rate cut odds have increased in the aftermath of the FOMC statement, although not by the full amount of the surprise cut, indicating that the markets understand that today's action reduces the need for future interest rate cuts. The market is priced for 80% odds of a 25 basis point cut at the Oct. 31 FOMC meeting, with an additional 14 basis points in cuts built into the fed funds futures contract used as a gauge for the October meeting.

For year-end, the market is priced for 100% odds of one 25 basis point cut (a 4.50% funds rate), and for close to 50% odds of a cut to 4.25%. An additional 15 basis points of rate cuts are priced in today compared to yesterday.

Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of the revised investment classic, The Money Market, first published in 1978 by Marcia Stigum, and The Strategic Bond Investor. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of Bondtalk.com, a popular Web site covering the bond market and the economy. Crescenzi appreciates your feedback; click here to send him an email.

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