Economists Versus Traders on 2008 Fed Rate Increases

Although a Bloomberg article, “Bernanke Plays `Dangerous Game’ Balancing Rate Talk With Action,” focused on the Fed’s rate dilemma, it also in passing revealed a sharp difference of opinion on the central bank’s likely actions later this year between economists and market participants:

While Bernanke’s warning that the Fed will “strongly resist” a jump in inflation expectations led traders to bet on a rate increase, economists are more skeptical. All 101 in a Bloomberg News survey said the Federal Open Market Committee will keep the benchmark rate unchanged tomorrow and most analysts this month predicted officials will stand pat until 2009.

“That’s the dangerous game,” said Scott Anderson, senior economist in Minneapolis at Wells Fargo & Co., the fourth- largest U.S. bank by market value. “Instead of putting the shot across the bow on inflation,” Bernanke might have “held off a few more months to let the credit crisis heal a little bit more.”…

There are widespread expectations among traders for a rate rise in the next three months: There are 36 percent odds of a boost in August and 93 percent in September, according to futures contracts on the Chicago Board of Trade.

The balance of the year will provide an interesting test case of whose needs take precedence as far as the central bank is concerned. Heretofore, it has seemed almost deathly afraid of disappointing Fed futures expectations. At the same time, it has also been hyper-responsive to any sign of distress in the financial services industry, leading one wit to observe, “75 is the new 25.”

Although it’s generally unwise to side with economists when forecasting is concerned. the reason for their near-unanimity of opinion is their expectation of continued weakness in the financial sector. Personally, I think it’s even worse than that, that new problems will surface (such as rising woes at regional and smaller banks, renewed difficulties at the large players as the impact of the monoline downgrades ripple through). And if the stresses are visible, or worse, disruptive, the views of the Fed funds traders can turn on a dime.

The wild card here is that the number of open seats on the FOMC gives the bank presidents more say, and they tend to be more vocal and hawkish. Absent tangible evidence of worsening conditions in the financial services industry, their views will probably prevail

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  1. Anonymous

    Whatever the Fed does will be wrong.
    As Jim Sinclair likes to say, “There is no practical solution.” The debt is just beyond comprehension.

    These rate reductions have been for the banks only and staves off another major meltdown on a temporary basis.

  2. Michael McKinlay

    The first post had it right … meltdown ahead …

    I always thought they would postpone it until after the elections but now I’m not so sure. A burst of oil above $150 for any length of time would probably do it.

    The monolines are now essentially defunct and with that trillions of dollars in guarantees in bonds, swaps and derivatives are now naked and ready to be downgraded.

    Bernanke isn’t pushing on a string, he’s pushing a corpse.

  3. Anonymous

    So far what we’ve seen has been caused by borrowing short term and lending long and not being able to roll the debt.

    The subprime defaults/costs are still in the future (think pension plans, insurance companies ie: those who really lend long term).

    There’s also the costs of inflation to pay. Having lent long isn’t going to produce happiness.

    None of this relates to the Fed. The purpose of the fed is just to keep the game in motion as long as possible.

    PS: I really liked the page in Greenspans book where he is talking to some banker(?) for China who says you aren’t a capitalist country, you had price controls. And Greenspan (he who controls interest rates) says we learned our lesson. I only read that one page — it was enough.

  4. Anonymous

    Sy Krass said,,,

    When this collapses it is going to collapse hard and it is going to collapse fast. Previous comments have it right too much debt now and not enough new money. It will be so fast because ultimately it will suck liquidity from one end of the economy to the other. Ultimately even the federal govt itslef won’t be able to borrow because there won’t be any money left. And when that happens, the abyss…

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