360 Degrees on the FOMC

Robert Marcin, Howard Simons, Liz Rappaport, Chip Hanlon and more examine the Fed's policies from all angles.
Publish date:

Editor's Note: This edition of "360 Degrees" examines the

Federal Open Market Committee's

decision to raise official interest rates to 5% Wednesday. The following is a sample of the expert commentary and dialog on the subject Wednesday on


before and after the announcement.


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Bernanke Walks the Thin Line, by Liz Rappaport

Little changed in the FOMC's statement Wednesday, but the Ben Bernanke-led Fed accomplished the difficult task of providing something for each of its varying constituencies.

Bond market vigilantes took the policy statement as not hawkish enough, and stock market bears were similarly distraught. But the statement contained enough backbone to stem the dollar's recent decline and simultaneously provide hope to those expecting a pause at the June meeting. Given the breathless anticipation of the statement, the Fed deserves credit for crafting a statement that was all things to different people and didn't prompt major upheaval in the financial markets.

Of course, the Fed could be seen as having merely delayed the inevitable and leaving investors pretty much where they were prior to the March meeting. The debate now turns to whether the Fed will hike rates again in June or pause after collecting data.

"The Fed stated it will be taking its cue from the market more than it has in the past," says John Lonski, chief economist at Moody's Investors Service. "If forthcoming data is going to be inflationary and bond yields rise, the Fed tightens. If the market does not believe data indicates an increase in inflation risk, it will enter into a pause that may well continue into a stop."

The bond market, which is keenly sensitive to inflation, felt the statement didn't go far enough. The yield on the benchmark 10-year rose to 5.13% from 5.10% before the meeting.



the Federal Reserve will be an inflation-fighter and preemptively thwart off many of the mounting inflation pressures by raising its overnight borrowing target," says Richard Yamarone, director of economic research at Argus Research Corp. "But hope isn't a strategy, it's an emotion. In the event the Fed does sit sidelined, we believe the bond market will step up and do the Fed's work for them."

Stock market bears were similarly distraught, even if the stock market itself had a fairly muted reaction to the statement and the recent trend of outperformance by blue chips continued.

To read the rest of this article, please click here.

The Fed Should Pause, by Bob Marcin

I continue to believe that the Fed should pause after raising rates to 5% today. Now, many believe that they should continue hiking, citing commodity prices and strong growth as fundamental reasons.

Those same individuals probably cheered the 1% fed funds rate. I think that rampant inflation is as probable today as deflation was two years ago -- not very.

I know gold is $700. I know that oil is $71. But a 6% fed funds rate will not stop commodity speculation. It might just trash the real estate market further. And today's purchase-mortgage apps were downright ugly.

Despite Larry Kudlow's incessant characterization of the current economy as booming, economic tops are set under those conditions. Things will slow in the next few quarters, and noticeably, in my opinion.

Unit-labor costs remain controlled, and many consumer companies are having a difficult time passing on material-cost increases. If the Fed wants to do something about commodities, it should jawbone the commodity exchanges into dramatically hiking margin requirements. That might take some pressure off inflation without hurting the real economy.

It's what I proposed for stocks in the technology bubble, but was never implemented. The Fed ignored that bubble, it should not ignore the commodity one.

If inflation accelerates from here, the Fed can always resume rate hikes. However, if it raises too much, it risks a major problem with this very levered economy. The downside of hiking too much far outweighs the downside of pausing too early. It should give all of the restrictive forces in the economy time to slow economic growth.

Fed Offers the Right Blend, by Tony Crescenzi

The FOMC statement was largely as expected, given that it indicates that no hike is likely in June and there could well be additional hikes at future meetings.

The only people who should be surprised today are those who expected the Fed to indicate an end to rate hikes. This is the right blend for the markets, just as it was in January and March, at least as opposed to an outright stoppage, because an end to hikes would act as an accelerant to the dollar's fall, the bond market's fall and the surge in commodities prices.

The Fed showed its deference to lags in the first paragraph:

The Committee sees growth as likely to moderate to a more sustainable pace, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.

And the FOMC further warned that it is strongly biased toward future hikes, even though it might pause in June:

The Committee judges that some further policy firming may yet be needed to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information.

The key word there is


(author's highlight), as it has the same meaning as the "in future months" that I thought might be added to the line "some further policy firming may be needed," which was in the March FOMC statement. This addition of both "yet" and the prerequisites that the Fed laid out in the same sentence is the Fed's way of saying, "We don't think that there will be enough data to cause us to raise interest rates in June, but the 'evolution' of the data could yet push us to raise interest rates in August."

By emphasizing that further policy firming may yet be needed "to address inflation risks," the Fed added a new phrase. The Fed likely added it to indicate that strong economic news and other factors such as the weakening dollar and rising commodity prices could result in a rate hike, and that it is the inflation process that the Fed will address, not necessarily the upcoming inflation news by itself.

In other words, the Fed won't worry about upcoming inflation news if the inflation process is moving favorably; i.e. the economy is slowing sufficiently to turn any bad inflation news of today into more favorable news tomorrow.

Of Fuel and Funds, by Howard Simons

Now that the FOMC has raised rates for the 16th consecutive time and threatens to unleash the feared "17 steps and a stumble" trade, let's turn our attention to the other headline grabber -- gasoline.

The June contract is up close to 13 cents on the day to $2.175; its high close was $2.216 on April 19. Technically, it rallied up to the top of a bull-flag formation; any breakout could take us to $2.35, give or take.

Here's the trick question. Which increase gives stocks the greatest headwind, federal funds, gasoline, both or neither? The evidence since 2004 suggests the answer is neither. After all, the average annual total return on the

S&P 500

is about 9.3% since it became apparent in April 2004 the Federal Reserve would begin its ongoing campaign. Unleaded gasoline was just about $1 a gallon cheaper in April 2004.

What does this prove? Both money and energy are costs of doing business. If American business can add value to both and make a profit, stocks will rise accordingly. If you want lower interest rates and cheaper gasoline, start wishing for a recession.

Will this deter anyone from treating either rising fuel or funds as a negative? Not a chance.

Dollar Bears Listen When Fed Talks, by Chip Hanlon

The Fed just can't be done.

As Tony Crescenzi

writes here, this is the message being clearly delivered to Ben Bernanke from gold, silver and other hard assets around the world. Rising oil, for example, does not cause inflation but is a symptom of it, and all commodities are telling the Fed and other central banks around the world that there simply remains too much liquidity and that they have been too tentative thus far in their efforts to tighten.

Should the Federal Reserve ignore the market today and state essentially that it is going to pause, then all bets are off, and we may run the risk of the U.S. dollar crisis that so many permabears have been hoping for. (Literally, many of them don't believe in, but wish for, such an outcome.)

It's clear by how the dollar has traded in the last two weeks that the market doesn't believe rates are high enough to support our currency. And while it was pretty surprising to see Bernanke make such an important gaffe, the most shocking comment of the last two weeks was his own concern, as he reportedly told


Maria Bartiromo, about being perceived as dovish on inflation.

The market has ears, and Bernanke is the one who talked of

printing presses

in November 2002. And the market also has eyes, and it has read his thoughts on what caused the

Great Depression

. Until he proves otherwise, this inherently means he's not an inflation hawk.

Thus, it should be no surprise that the market saw Bernanke's comment of two weeks ago, that the Fed was perhaps ready to pause even in the face of rampant inflation, as confirmation of his dovishness and that it treated the dollar accordingly.

The fact that Ben Bernanke had no idea he is seen as an inflation dove is what is truly astonishing.

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FOMC Recap: What Has Changed, by David Merkel

Economic growth has been quite strong so far this year. The Committee sees growth as likely to moderate to a more sustainable pace, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.

The first thing to note is the FOMC's view that growth is likely to moderate, partly due to housing. Second, this is the first statement which recognizes the lag effects of both interest rates and energy. Both of these are somewhat dovish, and would imply fewer tightenings to come.

The Committee judges that some further policy firming may yet be needed to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information. In any event, the Committee will respond to changes in economic prospects as needed to support the attainment of its objectives.

The underlines in the above paragraph indicate changes. In the old statement, the objective of policy was to "the risks to the attainment of both sustainable economic growth and price stability roughly in balance," which emphasized some worry about growth, partly off the slow first-quarter GDP. Now the FOMC's not worried about growth; it is only worried about inflation, and that is hawkish.

The use of the word "implied" probably means that the FOMC is not going to be looking at what economics numbers are as they are announced, but implied future values that can be derived from forward-looking markets, like the various bond markets, including TIPS, and maybe credit spreads and real estate prices.

What hasn't changed: the FOMC still doesn't see a lot of current inflation, and still thinks its policy will meet the challenges to economic stability. (When will it drop that language? I mean, if it weren't true, wouldn't it be adopting a different policy? Seems meaningless to me.)

In closing, I think this is what the statement would look like if the FOMC was going to pause in June. I expect it to do that, but do I get the luxury of making my forecasts "data dependent?"

Then, overnight, David offered additional insight in a Columnist Conversation post, Notes on Two Neighbors

I have commented over the last dozen or so FOMC meetings on the sloppiness of the NY Federal Reserve Open Market Operations desk letting the fed funds rate rise in advance of the meeting, telegraphing the outcome. I was busy this time, and didn't pay attention until after the announcement. They were better this time. The rate drifted up a little, starting on April 27, and hung mainly around 4 7/8% from April 28 to May 8. Then the NY Fed managed to inject enough temporary liquidity to bring the rate down to 4.75% on May 9. Today, fed funds only closed at 5% after the announcement.

The reason I mention this is that it indicates that the Fed is getting serious about not telegraphing its intentions. It (most likely) will not let the fed funds rate signal its intentions before the next meeting.

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.

Charles P. Hanlon focuses on nondollar investments. He is currently the president of Delta Global Advisors.

Robert Marcin is the founder of Defiance Asset Management, a private investment management firm.

David J. Merkel, CFA, FSA, is a senior investment analyst at Hovde Capital responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry.

Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of

The Dynamic Option Selection System


Liz Rappaport is Markets Columnist for TheStreet.com.