Fed Shows Resolve

The Federal Reserve went for the jugular by indicating increased concern about inflation even though the most recent set of economic data and developments in the financial markets signal relief on the inflation front. This may worry those who would rather the Fed back away from any inclination toward interest rate hikes and possibly move toward interest rate cuts, but it is probably the best thing for the economy and the financial markets, because it will help kick inflation while it's down (or moving down) and lower the chances at a revival of both the decline in the value of the dollar and the rally in commodity prices. Of course, the Fed can't raise interest rates under present conditions with economic growth and asset prices falling everywhere, but it can talk with resolve about wringing the economy of the undesirably high inflation rates that have done significant harm to the economy.

Three Signs of Increased Fed Resolve

In addition to the lack of any reference to the recent moderation in inflation pressures and the drop in commodity prices in particular, there were three ways in which the Fed showed its resolve on inflation in today's policy statement. First, although the Fed did not say this time around (as it did in June) that downside risks to growth had "diminished somewhat," no significant weight to the recent intensification of downside risks was given, despite the abundance of evidence (weak car sales, rising unemployment, credit market problems, weakening global economic growth). Second, the Fed said that despite its concerns about downside risks to growth, that "the upside risks are also of significant concern to the committee," language not previously used. Third, the expression of inflation risks was placed in a paragraph of its own and in addition to a paragraph devoted to the inflation situation. This was the exclamation point to the policy statement.

The lone dissent, the fifth in a row for Dallas Fed President Fisher, was probably kept down by the intensification of the Fed's remarks; hawks are circling the Fed Board, particularly Minneapolis President Stern and Philadelphia President Plosser.

By choosing to be opportunistic today, the Fed has positioned itself to deploy a strategy of "opportunistic disinflation" whereby in future months (well into 2009) the Fed will be able to defend or maintain inflation at the new, lower rate inflation falls to when the full impact of the global economic slowdown and other inflation-snuffing factors have their full effect. It would be far worse for the Fed to be complacent and believe that inflation has gone/will go away this early in the game, event though recent developments make it more likely.

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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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