In the Ring With the Fed

It is as if the debt and currency markets are trying to give the Fed a wake-up call. They're saying the Fed historically has kept rates too low for too long and too high for too long. And the current Fed is the least experienced in modern history. Donald Kohn, the vice chairman, has more experience than everyone else on the board combined.

From the perspective of many economists, the Fed is whistling past the graveyard. To address the slowdown in 2001 and mitigate the impact of the collapse of the equity-market bubble, policymakers created another bubble in housing. That bubble has now popped, and the full extent of it is still working its way through the economy.

Many of the more pessimistic forecasts warn that housing and residential construction not only will be a headwind for the economy for the coming quarters but also will likely have a broader and deeper impact than Fed officials seem willing to recognize.

So Who Is Right?

One characteristic of the current cycle is that the market has consistently underestimated the duration and magnitude of Fed tightening. Remember how the year began "one and done" under Greenspan. There have been a number of swings in market expectations toward an early cut, only to have them reconsidered.

Another market bet that has proven wrong is the one against the U.S. consumer. We've been told that consumers are tapped out, have negative savings and have taken equity out of their homes to finance their excessive consumption. But the demise of the American consumer has been grossly exaggerated.

The key to U.S. consumption is income, and that continues to hold up fine. The latest data for October showed U.S. personal income up 5.8% year over year. The 0.4% monthly rise in October compares with an average monthly gain of 0.5% in the third quarter and 0.2% in the second quarter.