Merk Investments: FOMC Meeting

The FOMC today chose to hold rates steady at 2.0%. The committee chose to alter the growth paragraph to reflect the slight firming in economic activity due to household spending during the first two months of Q2’08. The committee continued to make the case that they expect inflation to moderate on the back of a weak economy later this year, although they were careful to explicitly note that some indicators of inflation expectations remain elevated and remain uncertain about the overall pricing outlook remains high.

Mr. Bernanke’s inclusion of the risks to the economy to inflation appeared to be sufficient to move former dissident Charles Plosser into the supporter column, but was not enough to convince uber-hawk Richard Fisher to follow. We do not believe that this statement revealed a true bias towards inflation and the statement in our opinion remains balanced and the Fed in a position of data dependency.

The major change in the statement was the addition to the language in the first sentence of the pricing paragraph that the “committee expects the inflation to moderate later this year and next.” The insertion of the phrase “and next” represents another step backward from the hawkish rhetoric that roiled the federal funds market over the past few weeks. It diminishes the impact of the acknowledgement of upside risks to inflation and should give cause for the market to reconsider the pricing in of rate hikes throughout the remainder of the year. We anticipate that the rate hike currently priced in for September will wither away in the heat of the summer slowdown in the economy.

The most troubling element of the statement is that the committee continues to depend on the refrain that inflation will eventually ease; yet they extended the interval in which that may occur into 2009. This is tantamount to admitting that inflation has move far higher than the committee ever thought it would and acknowledging that it may be some time before it subsides. This is very different story than that which the committee has been pushing and we expect to see that reflected in the upcoming minutes and the revised growth forecasts that will accompany it. This is not a Fed poised to raise rates to curb the upside risks to inflation.