Merk Investments: FOMC minutes - Fed in Flux
The minutes to the April 29-30 FOMC meeting suggested a Fed on its heels, caught between an economy grinding to a halt and inflation surging. The Fed reduced its growth forecast to 0.3-1.2%, which is below the lower limit of 1.2% in it previous estimate. The projection on inflation saw the Fed raise its estimate on the core PCE deflator to 2.2%-2.4%, above the upper end of its recent forecast of 2.2%. Several members of the committee expressed a clear reluctance to continue cutting the federal funds rate in response to the ongoing credit crisis. Overall the FOMC committee judged that the risk between weaker growth and rising inflation as roughly in balance.
The committee noted that labor conditions continued to ease and raised their projections of unemployment to 5.5-5.7%, above the 5.2%-5.3% estimate released in January. The committee reported that gains in labor compensation remained moderate were unlikely to pick up over the next few quarters.
Although, the Fed did revise its short-term inflation outlook, it did suggest that inflation over the horizon would ease based on prices embedded in futures contracts that implied a leveling-off of energy and commodity prices. At this juncture to suggest that domestic, much less global aggregate demand for energy and commodity prices would level off does seem a bit odd. While, the Fed can make the case for a lack of impact on wage pressures due to the relatively flexible wage and price environment in the US, that is not necessarily the case on in the international context. With a weak dollar, soaring import prices and robust external demand for energy and commodities the risks associated with inflation in our assessment do seem a bit more potent than the minutes from the FOMC meeting seem to suggest. Moreover, we do expect demands for wage increases in among our major trading partners to pick up steam as the year progresses.
Both the tone and tenor from the minutes suggest a Fed in flux. Based on our reading of the statement the Fed intends to rely on the unorthodox measures that it has taken to inject liquidity into the economy to prop up the financial system, but for the foreseeable future it has taken the blunt instrument of the federal funs rate off the table. We do not expect the Fed to move on rates until Q2’09 and we expect them to raise rates at that time.
Joseph Brusuelas
Merk Investments
Chief Economist/VP Global Strategy
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