Tag Archives: Fed

Manpower survey better than expected

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Bernanke stated he was watching the labor markets closely, right up to the meeting, and the latest survey further confirms its holding up at least as well as expected, if not quite a bit better.

The headline and lead in, however, continue to indicate a reporting bias toward a slowdown:

U.S. Employers Trim First-Quarter Hiring Plans, Manpower Says

By Bob Willis

Dec. 11 (Bloomberg) — Employers in the U.S. trimmed hiring plans for the first quarter of 2008 as the economy cools, according to a private survey released today.

Manpower Inc., the world’s second-largest provider of temporary workers, said its employment index for January through March fell to 17, the lowest since the first three months of 2004, after holding at 18 for the three prior quarters.

The decline wasn’t large enough to signal employment would slump, suggesting the labor market is holding up enough to sustain consumer spending. Federal Reserve policy makers, who are forecast to lower interest rates later today, are counting on rising wages to help Americans weather the housing recession.

“We’ve kind of pointed down a little, but we didn’t fall off a cliff like we did in other downturns,” Jeffrey Joerres, chief executive officer of Milwaukee-based Manpower, said in an interview. “Companies may not be euphoric about hiring, but they are still hiring.”

Right, so why wasn’t the headline ‘survey doesn’t signal a slump’? The reporting bias has been as strong as I’ve ever seen it.

The survey was in line with the Labor Department’s monthly jobs report issued last week. Employers added a greater-than- forecast 94,000 workers to payrolls in November and the unemployment rate held at 4.7 percent. The economy has created an average 118,000 jobs a month so far this year, compared with 189,000 a month in 2006.

These are not rate cut numbers.

Manpower’s index slumped 8 points in the second quarter of 2001, at the start of the last recession.

Before adjusting for seasonal variations, 22 percent of the roughly 14,000 companies surveyed said they will boost payrolls in the first quarter, down from 27 percent in the previous three months.

Little Change

Twelve percent said they’d trim hiring in the coming quarter, and 60 percent anticipated no change, the survey showed.

The overall index subtracts the percentage of employers planning to cut jobs from those who plan to add workers and adjusts the results for seasonal variations.

The world’s largest economy will expand at a 1 percent annual pace this quarter, bringing 2007’s growth rate to 2.2 percent, according to the median estimate of economists surveyed this month by Bloomberg
News. It grew at a 4.9 percent annual pace in the third quarter and 2.9 percent for all of 2006.

That’s a two quarter average of 3%, as actual employment and output grew modestly and inventory in Q3 borrowed some GDP from Q4. And the fed knows that if recent history is any guide, there is a good chance net exports were higher than expected in Q4 and it could be revised up.

The Fed will probably lower its target lending rate by a quarter point to 4.25 percent later today, its third consecutive reduction, according to a separate Bloomberg survey.

That’s the consensus, and the fed may do it out of fear that if they do not accomodate what markets have priced in, the sky will fall.

Half Limit Hiring

Employers in five of 10 industries polled by Manpower planned to limit hiring next quarter compared with the previous three months. Manpower’s measure of hiring intentions was weakest for construction companies. The index for government agency hiring showed the biggest drop.

And the risks are to the upside, as construction is already near zero. There is no where to go but unchanged or up.

Hiring plans at all but one of the industries were lower than year-ago levels, the report showed. Manufacturers of long- lasting goods, such as computers and appliances, projected little change from the first quarter of 2007.

The hiring outlook is strongest at mining companies, followed by service industries and wholesalers.

Regionally, employers in the Northeast, South and West predict no change in hiring, while employers in the Midwest anticipate a slowdown in activity.

Globally, hiring plans in Peru, Singapore, India, Argentina, South Africa, Australia and Japan were among the strongest, while employers in Ireland reported the weakest hiring plans.

The Manpower survey is conducted quarterly and has a margin of error of plus or minus 0.8 percentage point in the U.S. and no more than plus or minus 3.9 percentage points for national, regional and global
data.

To contact the reporter on this story:Bob Willis in Washington
bwillis@bloomberg.net .

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Fed expected to lower rates despite raging inflation – MarketWatch

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And the risk is headlines could get much worse after they cut.

For example:

‘Oil prices rise as Fed rate cuts drive down the dollar’

‘Fed cuts rates, driving up gas prices, to bail out banks’

MarketWatch article – Fed expected to lower rates despite raging inflation

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Bowling alley to run out of points!

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National Debt Grows $1 Million a Minute

The Associated Press
Monday 03 December 2007

Washington – Like a ticking time bomb, the national debt is an explosion waiting to happen. It’s expanding by about $1.4 billion a day – or nearly $1 million a minute.

What’s that mean to you?

It means net financial assets are growing by only that much. 1.5% of GDP isn’t enough to support our credit structure needed to sustain aggregate demand over time.

It means almost $30,000 in debt for each man, woman, child and infant in the United States.

No, it means 30,000 in net financial assets for each.

Even if you’ve escaped the recent housing and credit crunches and are coping with rising fuel prices, you may still be headed for economic misery, along with the rest of the country.

Yes!

That’s because the government is fast straining resources needed to meet interest payments on the national debt, which stands at a mind-numbing $9.13 trillion.

No, it’s because the deficit is too small to supply the net financial assets we need to sustain demand, given the institutional structure that removes demand via tax advantage savings programs.

And like homeowners who took out adjustable-rate mortgages, the government faces the prospect of seeing this debt – now at relatively low interest rates – rolling over to higher rates, multiplying the financial pain.

Only if the fed hikes rates.

So long as somebody is willing to keep loaning the U.S. government money, the debt is largely out of sight, out of mind.

Government securities offer us interest bearing alternative to non interest bearing reserve accounts.

But the interest payments keep compounding, and could in time squeeze out most other government spending –

Operationally, spending is totally independent of revenues. The only constraints are self imposed.

leading to sharply higher taxes or a cut in basic services like Social Security and other government benefit programs. Or all of the above.

Only if congress votes that way..

A major economic slowdown, as some economists suggest may be looming, could hasten the day of reckoning.

The national debt – the total accumulation of annual budget deficits – is up from $5.7 trillion when President Bush took office in January 2001 and it will top $10 trillion sometime right before or right after he leaves in January 2009.

Too small as it is the equity behind our credit structure.

That’s $10,000,000,000,000.00, or one digit more than an odometer-style “national debt clock” near New York’s Times Square can handle. When the privately owned automated clock was activated in 1989, the national debt was $2.7 trillion.

It is also the national ‘savings’ clock as government deficit = non government accumulation of net financial dollar assets.

It only gets worse.

So does this article.

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Over the next 25 years, the number of Americans aged 65 and up is expected to almost double. The work population will shrink and more and more baby boomers will be drawing Social Security and Medicare benefits, putting new demands on the government’s resources.

The government spends by changing the number in someone’s bank account. Spending puts the same demands on government resources as running up the score at a football game puts strain on the stadium’s resources needed to post the score.

These guaranteed retirement and health benefit programs now make up the largest component of federal spending. Defense is next. And moving up fast in third place is interest on the national debt, which totaled $430 billion last year.

All interest expense is net income to the non government sectors.

Aggravating the debt picture: the wars in Iraq and Afghanistan, which the nonpartisan Congressional Budget Office estimates could cost $2.4 trillion over the next decade

That will be an aggregate demand add. What are the subtractions going to be? Increased pension funds assets, IRA’s, insurance reserves, and all of the other tax advantage ‘savings incentives’. To date, these have dwarfed government deficit spending and resulted in a chronic shortage of aggregate demand and massive economic under performance.

Despite vows in both parties to restrain federal spending, the national debt as a percentage of the U.S. Gross Domestic Product has grown from about 35 percent in 1975 to around 65 percent today.

Last I heard it was still 35%? But, as above, whatever it is, it is still not sufficient to support demand at ‘full employment’ levels. Our employment rate assumes large chunks of the population aren’t working because they don’t want to and wouldn’t work if desirable jobs were offered to them. The experience of the lat 90’s shows this isn’t true. With the right paid jobs available, employment could increase perhaps by 10%.

By historical standards, it’s not proportionately as high as during World War II – when it briefly rose to 120 percent of GDP, but it’s a big chunk of liability.

Didn’t seem to hurt war output!

“The problem is going forward,” said David Wyss, chief economist at Standard and Poors, a major credit-rating agency.

“Our estimate is that the national debt will hit 350 percent of the GDP by 2050 under unchanged policy. Something has to change, because if you look at what’s going to happen to expenditures for entitlement programs after us baby boomers start to retire, at the current tax rates, it doesn’t work,” Wyss said.

The only thing that ‘doesn’t work’ is the 10% of the work force that is kept on the sidelines by too tight fiscal policy.

With national elections approaching, candidates of both parties are talking about fiscal discipline and reducing the deficit and accusing the other of irresponsible spending.

Yes, and that is the biggest continuing systemic risk to the real economy – not a bunch of write downs in the financial sector.

But the national debt itself – a legacy of overspending dating back to the American Revolution – receives only occasional mention.

Who is loaning Washington all this money?

Who has all the money looking to buy government securities is the right question. And it’s the same funds that come from deficit spending. Deficit spending is best thought of as government first spending, then selling securities to provide those funds with a place to earn interest. The fed calls that process ‘offsetting operating factors’.

Ordinary investors who buy Treasury bills, notes and U.S. savings bonds, for one. Also it is banks, pension funds, mutual fund companies and state, local and increasingly foreign governments. This accounts for about $5.1 trillion of the total and is called the “publicly held” debt.

It’s also called the total net financial assets of non government sectors when you add cash in circulation and reserve balances kept at the fed.

The remaining $4 trillion is owed to Social Security and other government accounts, according to the Treasury Department, which keeps figures on the national debt down to the penny on its Web site.

Intergovernment transfers have no effect on the non government sectors’ aggregate demand.

Some economists liken the government’s plight to consumers who spent like there was no tomorrow – only to find themselves maxed out on credit cards and having a hard time keeping up with rising interest payments.

Those economist have it totally backwards and are a disgrace to the profession.

“The government is in the same predicament as the average homeowner who took out an adjustable mortgage,” said Stanley Collender, a former congressional budget analyst and now managing director at Qorvis Communications, a business consulting firm.

Wrong.

Much of the recent borrowing has been accomplished through the selling of shorter-term Treasury bills. If these loans roll over to higher rates, interest payments on the national debt could soar.

Wrong. The fed sets short term rates, not markets, and long term rates as well if it wants to.

Furthermore, the decline of the dollar against other major currencies is making Treasury securities less attractive to foreigners – even if they remain one of the world’s safest investments.

For now, large U.S. trade deficits with much of the rest of the world work in favor of continued foreign investment in Treasuries and dollar-denominated securities. After all, the vast sums Americans pay – in dollars – for imported goods has to go somewhere.

He’s getting warmer with that last bit!

But that dynamic could change.

“The first day the Chinese or the Japanese or the Saudis say, `we’ve bought enough of your paper,’ then the debt – whatever level it is at that point – becomes unmanageable,” said Collender.

Define ‘unmanageable’ please.

A recent comment by a Chinese lawmaker suggesting the country should buy more euros instead of dollars helped send the Dow Jones plunging more than 300 points.

Ok.

The dollar is down about 35 percent since the end of 2001 against a basket of major currencies.

Ok. Is that all there is to ‘unmanageable’? How about 10 year treasuries coming down below 4% as the dollar went down? How does he reconcile that?

Foreign governments and investors now hold some $2.23 trillion – or about 44 percent – of all publicly held U.S. debt. That’s up 9.5 percent from a year earlier.

Point?

Japan is first with $586 billion, followed by China ($400 billion) and Britain ($244 billion). Saudi Arabia and other oil-exporting countries account for $123 billion, according to the Treasury.

“Borrowing hundreds of billions of dollars from China and OPEC puts not only our future economy, but also our national security, at risk.

In what way? This is nonsense.

It is critical that we ensure that countries that control our debt do not control our future,” said Sen. George Voinovich of Ohio, a Republican budget hawk.

They already don’t. We control their future. Their accumulated funds are only worth what we want them to be. We control the price level. They are the ones at risk.

Of all federal budget categories, interest on the national debt is the one the president and Congress have the least control over. Cutting payments would amount to default, something Washington has never done.

Why would they? Functionally that’s a tax, and there are sufficient legal tax channels. So why use an illegal one?

Congress must from time to time raise the debt limit – sort of like a credit card maximum – or the government would be unable to borrow any further to keep it operating and to pay additional debt obligations.

Yes, that is a self-imposed constraint, not inherent in the monetary system that needs to go. If congress has approved the spending, that is sufficient.

The Democratic-led Congress recently did just that, raising the ceiling to $9.82 trillion as the former $8.97 trillion maximum was about to be exceeded. It was the fifth debt-ceiling increase since Bush became president in 2001.

Democrats are blaming the runup in deficit spending on Bush and his Republican allies who controlled Congress for the first six years of his presidency.

Not that I approve of the specifics of his tax cuts and spending increase, but good thing he did run up the deficit or we would be in the middle of a much worse economy.

They criticize him for resisting improvements in health care, education and other vital areas while seeking nearly $200 billion in new Iraq and Afghanistan war spending.

Different point.

“We pay in interest four times more than we spend on education and four times what it will cost to cover 10 million children with health insurance for five years,” said House Speaker Nancy Pelosi, D-Calif. “That’s fiscal irresponsibility.”

She is way out of paradigm. We can ‘afford’ both if the real excess capacity is there without raising taxes.

Republicans insist congressional Democrats are the irresponsible ones. Bush has reinforced his call for deficit reduction with vetoes and veto threats and cites a looming “train wreck” if entitlement programs are not reined in.

Both sides are pathetic.

Yet his efforts two years ago to overhaul Social Security had little support, even among fellow Republicans.

It was ridiculous. There is no solvency risk with social security or any other government spending requirement. Only a potential inflation risk. And the total lack of discussion regarding that is testimony to the total lack of understanding of public finance.

The deficit only reflects the gap between government spending and tax revenues for one year. Not exactly how a family or a business keeps its books.

Even during the four most recent years when there was a budget surplus, 1998-2001, the national debt ranged between $5.5 trillion and $5.8 trillion.

As in trying to pay off a large credit-card balance by only making minimum payments, the overall debt might be next to impossible to chisel down appreciably, regardless of who is in the White House or which party controls Congress, without major spending cuts, tax increases or both.

“The basic facts are a matter of arithmetic, not ideology,” said Robert L. Bixby, executive director of the Concord Coalition, a bipartisan group that advocates eliminating federal deficits.

Deficit terrorists.

There’s little dispute that current fiscal policies are unsustainable, he said.

Sad but true.

“Yet too few of our elected leaders in Washington are willing to acknowledge the seriousness of the long-term fiscal problem and even fewer are willing to put it on the political agenda.”

Fortunately!!!

Polls show people don’t like the idea of saddling future generations with debt, but proposing to pay down the national debt itself doesn’t move the needle much.

Our poor kids are going to have to send the real goods and services back in time to pay off the debt???? WRONG! Each generation gets to consume the output they produce. None gets sent back in time to pay off previous generations.

“People have a tendency to put some of these longer term problems out of their minds because they’re so pressed with more imminent worries, such as wages and jobs and income inequality,” said pollster Andrew Kohut of the nonpartisan Pew Research Center.

Good!

Texas billionaire Ross Perot made paying down the national debt a central element of his quixotic third-party presidential bid in 1992. The national debt then stood at $4 trillion and Perot displayed charts showing it would soar to $8 trillion by 2007 if left unchecked. He was about a trillion low.

Fortunately!

Not long ago, it actually looked like the national debt could be paid off – in full. In the late 1990s, the bipartisan Congressional Budget Office projected a surplus of a $5.6 trillion over ten years – and calculated the debt would be paid off as early as 2006.

That therefore projected net financial assets for the non government sectors would fall that much. Not possible!!! Causes recession long before that and the countercyclical tax structure fortunately builds up deficit spending (unfortunately via falling government revenue due to unemployment and lower profits) sufficiently to ‘automatically’ trigger a recovery.

Former Fed chairman Alan Greenspan recently wrote that he was “stunned” and even troubled by such a prospect. Among other things, he worried about where the government would park its surplus if Treasury bonds went out of existence because they were no longer needed.

Not to worry. That surplus quickly evaporated.

As above.

Mark Zandi, chief economist at Moody’s Economy.com, said he’s more concerned that interest on the national debt will become unsustainable than he is that foreign countries will dump their dollar holdings – something that would undermine the value of their own vast holdings. “We’re going to have to shell out a lot of resources to make those interest payments.

Interest payments do not involve government ‘shelling out resources’ but only changing numbers in bank accounts. ‘Unsustainable’ is not applicable.

There’s a very strong argument as to why it’s vital that we address our budget issues before they get measurably worse,” Zandi said.

“Of course, that’s not going to happen until after the next president is in the White House,” he added.

Might be longer than that.

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Discount rate

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Seems the fed now has some current evidence of how the discount rate can ‘cap’ year end funding costs for member banks if they remove the ‘stigma’ as recommended.

Lending at the discount window jumped to $2.15 billion on Dec. 5, the largest since September. It was the first period that covered the year-end and rates at the discount window were lower compared with the market, which may have led to increased borrowing.

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Fed’s best move

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From the Fed’s theoretical framework, their best move is:

♦ Cut the discount rate to 4.5

♦  Leave fed funds at 4.5

♦ Remove the stigma from the window

♦ Allow term window borrowing over the turn

♦ Accept any ‘legal’ bank assets as collateral from member banks in good standing

♦ Allow member banks to fully fund their own siv’s

♦ Do not allow banks to do any new sivs or add to existing siv assets, and let the existing assets run off over time.

This would:

♦ Close the FF/LIBOR spread stress for member banks

♦ Support market functioning

♦ Support portfolio shifts to the $

♦ Temper inflation pressures

♦ Restore confidence in the economy

♦ Regain Fed credibility

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Where the fed is vulnerable to the press

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While Fed gov Fisher was correct in stating the Fed isn’t held hostage to market pricing of fed funds when it makes its decision, the Fed is vulnerable to manipulation when it comes to inflation expectations.

Under mainstream theory, the ultimate cause of inflation is entirely attributed to the elevation of inflation expectations. The theory explains that price increases remain ‘relative value stories’ until inflation expectations elevate and turn the relative value story into an inflation story.

So far the Fed sees the price increases of recent years as relative value stories, as headline CPI has not been seen to leak into core. However, with capacity utilization high and unemployment low, the risk of inflation expectations elevating is heightened.

The Fed also knows that if the financial press starts harping on how high inflation is going, starts to intensely question Fed credibility, and calls the Fed soft on inflation, etc. etc. this process per se is capable of raising inflation expectations and potentially triggering accelerating inflation.

Therefore, I anticipate extended discussion at the meeting regarding ‘managing inflation expectations.’

And if they do cut the ff rate it will mean they continue to blinded by ‘market functioning’ risk and not willing to take the risk of not meeting market expectations of the cut.

Note the rhetoric of the financial press continues to turn in front of the meeting. First strong economy stories, then inflation stories, note this:

Bernanke May Risk `Fool in the Shower’ Label to Avert Recession

 

By Rich Miller

 

Dec. 10 (Bloomberg) — Federal Reserve Chairman Ben S. Bernanke may have to risk becoming the proverbial “fool in the shower” to keep the U.S. economy out of recession.

 

Renewed turbulence in financial markets puts Bernanke, 53, under pressure to open the monetary spigots wider to pump up the economy. Traders in federal funds futures are betting it’s a certainty the Fed will cut its benchmark interest rate from 4.5 percent tomorrow, and they see a better-than-even chance the rate will be 3.75 percent or below by April.

 

“The Fed has to assure the markets that it’s ready to ride to the rescue and cut rates by as much as necessary,” says Lyle Gramley, a former Fed governor who’s now a senior economic adviser in Washington for the Stanford Group Co., a wealth- management firm.

 

The danger of such a strategy is that Bernanke may become like the bather, in an analogy attributed to the late Nobel- Prize-winning economist Milton Friedman, who gets scalded after turning the hot water all the way up in a chilly shower. The monetary-policy equivalent would be faster inflation or another asset bubble in the wake of aggressive Fed action to tackle the slowdown in the economy.

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Strong $ AND strong yuan?

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Reminds me of the guy who loves money and wants to abolish taxes.

I do think the push is now for a stronger $, however, and we’ll see tomorrow if the Fed is on board.

As a friend of mine pointed out, a firming $ will likely trigger domestic and international portfolio reallocations back towards US equities.

Paulson Push for Stronger Yuan Weakened by Global M&A (Update3)

By Aaron Pan and Belinda CaoDec. 10 (Bloomberg)

As U.S. Treasury Secretary Henry Paulson visits China this week to push for faster appreciation of the yuan, the bigger issue may be what China is doing to strengthen the dollar.

Paulson’s fifth trip to the nation as Treasury Secretary has taken on added urgency as the U.S. grows more dependent on the dollar’s decline to lift exports and keep the economy out of recession. While the pace of the yuan’s gains tripled in the past 15 months, Chinese officials now plan to increase investments in America that may boost the U.S. currency instead.

“China at this stage needs to be looking to opportunities provided by the weakening U.S. dollar,” Ha Jiming, chief economist in Beijing at China International Capital Corp., the nation’s largest investment bank, said in an interview last week. “Very recently the government is becoming more interested in channeling money out of the country.”

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Balance of risks revisited

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“I don’t think that’s fair because I don’t — again, I think I’ve been pretty clear in saying we have an economy in the US that is fundamentally healthy. I think the jobs numbers today showed an economy that is fundamentally healthy. We’ve got very strong demand outside of the US. We’ve got exports growing, employment strong, inflation is contained. There are some risks, and I’m focused on those risks. That’s my job, and the biggest risk we have is housing and housing is a big drag on our economy and still, we’re going through a turbulent time in the capital markets. That’s a risk so we’re focused on the risks, but let’s not forget that we have a healthy economy.”
-Paulson

Two days before the Fed meeting Paulson is making the case that the economy is strong and he says the risks are *his job* and not the Fed’s job. Also, he said we have a strong $ policy after being silent on that for several months or more. No cut in the fed funds rate Tuesday would support his statements.
This article is the consensus view that’s pricing in a 25 cut on Tuesday.

US Fed seems poised to lower interest rates again at its meeting Tuesday

By JEANNINE AVERSA updated 6:46 a.m. ET, Sun., Dec. 9, 2007 WASHINGTON

A lot has changed since the U.S. Federal Reserve hinted two months ago that it might be finished cutting interest rates for a while. Credit has become harder to obtain,

Not true per se. Some spreads have widened, but absolute levels for mortgages, for example, are lower, and good credits are getting LIBOR minus funding in the bond markets. Yes, funding is more difficult and more expensive for ‘Wall Street’, but ‘Main Street’ borrowing needs are being met at reasonable terms.

Wall Street has convulsed again,

Stocks are generally up recently, and up for the year.

and the housing slump has intensified.

Maybe modestly, with some indicators flat to higher. Prices down for the quarter but YoY prices still higher as reported by the two broader measures.

As a result, policymakers at the central bank now appear to have changed their minds about the need to drop interest rates again.

Yes, that’s the appearance as seen by the financial press. (I haven’t read it that way.)

The Fed had cut rates twice this year and officials suggested in October that might be enough to help the economy survive the credit and housing stress.

And immediately afterward in several speeches as fed officials attempted unsuccessfully to take the cut out of Jan FF futures.

Then the problems snowballed,

There were no ‘snowballing problems’ only some spread widening even as absolute rates were generally lower and LIBOR rates going up over the next ‘turn’ at year end.

leading Fed Chairman Ben Bernanke to signal that one more cut might be needed.

Again, that’s how the financial press heard him. They never even reported firm the firm talk on inflation risks becoming elevated. The attitude is anything the fed says about inflation is just talk they have to say and that they don’t mean and not worth reporting.

Analysts expect the Fed to trim its key rate, now at 4.5 percent, by one-quarter of a percentage point at the meeting Tuesday. Some even speculate about the possibility of a half-point cut.

Yes, that’s the consensus.

Banks, financial companies and other investors who made loans to people with spotty credit

and fraudulent applications

or put money into securities backed by those subprime mortgages have lost billions of dollars (euros). Investors in the U.S. and abroad have grown more wary of buying new debt, thereby aggravating the credit crunch.

Yes. But again, ‘Main Street’ still remains well funded at reasonable terms.

All this has added to the turmoil on Wall Street, and Bernanke and other Fed officials say they must take it into account when deciding their next move.

Yes. And the economic numbers have come in strong enough for markets to take up to 35 bp out of the Eurodollars and nearly eliminate pricing in a 50 cut in the last few trading days.

But does lowering rates mean the Fed essentially is bailing out investors or encouraging more sloppy decision-making? In other words, what exactly is the Fed’s job?

Bernanke and other Fed officials say it is to make policy that keeps the economy growing and inflation low, a stable climate that benefits individuals, businesses and investors. The Fed also has a responsibility to ensure the banking system is sound and financial markets run smoothly.

Yes, exactly.

“There is a link between Wall Street and Main Street. The Fed is taking the right actions, but they should be careful,” said Victor Li, an economics professor at the Villanova School of Business.

That implies the question is whether the ‘market functioning’ risk is higher than the inflation risk, which is what the fed was addressing with the last two cuts.

This time ‘market functioning’ risk rhetoric has taken a back seat to ‘economic weakness’ risk rhetoric.
One more story of note:

Fed’s Inflation Measure Says Rates Can’t Fall as Traders Expect

By Liz Capo McCormick and Sandra Hernandez

Dec. 10 (Bloomberg) — The key to whether the Federal Reserve continues to cut interest rates after this week may hang on the wall behind economist Brian Sack’s desk in Washington.

Sack, head of monetary and financial market analysis at the Fed in 2003 and 2004, uses a chart that plots forward rates measuring investor expectations for inflation in five years. The gauge is so accurate that Sack and his colleagues persuaded the central bank to use it to help set policy. The chart is autographed by former Fed Chairman Alan Greenspan.

Right now, it shows current Fed Chairman Ben S. Bernanke may have less room to lower borrowing costs than investors in Treasuries anticipate, potentially setting bondholders up for a fall. The expected inflation rate, which Sack says replicates what Fed officials use, reached 2.91 percent last week, the highest since 2004, when the central bank began the first of an unprecedented 17 rate increases. The measure was at 2.79 percent on Nov. 1.

“One of the defining features of the Bernanke Fed to date is its emphasis on measures of longer-term inflation expectations,” said Sack, whose partners at Macroeconomic Advisors include former Fed Governor Laurence Meyer. “The Fed is willing to tolerate short-run movements in inflation, but only as long as those movements don’t appear to be dislodging long-run inflation expectations.”

Any evidence that accelerating inflation is becoming entrenched may heighten the Fed’s debate as policy makers consider cutting rates to keep the worst housing market in 16 years and mounting losses in securities related to subprime mortgages from tipping the economy into recession.

`Inflationary Pressures’

The gauge used by Sack, dubbed the five-year five-year forward breakeven inflation rate, suggests bets on lower Fed funds rates may be too bold.

Sack and other analysts derive the measure of inflation expectations from yields on five- and 10-year Treasury Inflation Protected Securities and Treasuries.

Five-year TIPS yield 2.15 percentage points less than five- year notes. This so-called breakeven rate is the average inflation rate investors expect over the next five years. The forward rate projects what the breakeven will be in five years, smoothing blips in inflation expectations from swings in oil prices or other events.

The five-year TIPS’ breakeven rate rose to a six-month high of 2.47 percent Nov. 27, the week after oil climbed to a record $99.29 a barrel, from about 1.9 percent on Aug. 31. As crude fell to a six-week low on Dec. 6, the breakeven rate declined and Sack’s measure dropped to 2.85 percent.

Bernanke mentioned the forward rate in a 2004 speech. Simon Kwan, a vice president at the San Francisco Fed, singled out the measure in a 2005 report, saying it “captures the market’s assessment of how well the Federal Reserve promotes price stability in the long run.”

Gaining Steam

Most analysts expect the economy to gain steam through 2008. Growth will slow to 1.5 percent this quarter from a 4.9 percent annual rate last quarter, and rise to 2.6 percent by 2009, according to the median forecast in a Bloomberg survey from Nov. 1 to Nov. 8.

The dollar, which is poised to depreciate against the euro for a second straight year, is also fueling inflation concerns. The currency’s drop and oil’s climb pushed import prices up 1.8 percent in October, the most in 17 months.

The government may say this week that consumer prices, which set TIPS rates, increased 4.1 percent last month from this year’s low of 2 percent in August and the biggest rise since July 2006, according to the median estimate of 19 economists. Food, imports and energy prices may raise inflation expectations, Bernanke said in a Nov. 30 speech in Charlotte, North Carolina.

To contact the reporter on this story:
Liz Capo McCormick in New York at Emccormick7@bloomberg.net ;
Sandra Hernandez in New York at shernandez4@bloomberg.net .

Last Updated: December 9, 2007 10:58 EST

‘The numbers’ could be used to support most anything the fed might do.The inflation numbers are both more than strong enough to support a hike, with CPI due to be reported north of 4.1 on December 14, and core moving up out of ‘comfort zones’ as well, not to mention ‘prices paid’ surveys higher and higher import and export with the weak $. Add to that the recent strong economic data – employment, CEO survey, and even car sales up a tad, etc. etc.

Inflation can also be dismissed as ‘only food and energy’ and due to fall based on (misreading) future prices as predictors of where prices will be, leaving the door open to cuts due to both ‘market functioning’ as justified by FF/LIBOR spreads at year end and the possibility of Wall Street spilling over to Main Street by ‘forward looking models’.

I can see the fed meeting going around in circles and it will come down to whether they care about inflation or not. Most of the financial community thinks they don’t, and they may be correct.

I think they do care, and care a lot, but that fear of ‘market functioning’ was severe enough to temporarily overcome their perceived imperative to sustain and environment of low inflation. And at the October meeting, the fear of some members has subsided enough to report a dissenting vote, along with half the regional banks voting against a cut.

I do think that if the fed cuts 25 it will be because they are afraid of what happens if they don’t as markets are already pricing in a 25 cut, even though this is what happened October 31, and Fisher said they wouldn’t price in a cut for that reason.

The Balance of Risks

So what would they anticipate if they don’t cut FF? The $ up, commodities down, stocks down, and credit spreads widening.

Is that risk less acceptable than the risk of promoting inflation and risking the elevation of inflation expectations if they do cut 25?

Then, there is the ‘compromise’ of cutting the discount rate and removing the stigma to address year end liquidity and ‘market functioning’ in general, with and/or without cutting the fed funds rate. The anticipated results would be a muted stock market reaction as FF/LIBOR spreads narrow, and hopefully, other credit spreads also narrow.

And if they cut the discount rate and don’t cut the FF rate, the $ will still be expected to go up and commodities down. And, with liquidity improved, stocks may be expected to do better as well.

But even though Kohn discussed this in his speech and others touched on the ‘liquidity versus the macro economy’ as well, there is no way to know how much consideration it may be given.

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Paulson on the dollar

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Maybe he knows the fed won’t cut the fed funds rate….

Paulson says economy healthy

updated 10:33 p.m. ET, Fri., Dec. 7,2007
SOURCE: Reuters

Treasury Secretary Henry Paulson said on Friday Washington was following a strong dollar policy and indicated he expected it to rebound, emphasizing the U.S. economy’s long-term strength should help the currency.

But Paulson warned in a radio interview in Cape Town that some aspects of the U.S. subprime mortgage crisis would become worse before getting better.

Paulson is in South Africa partly for a weekend meeting of finance chiefs from the Group of 20 economies, some of whom have expressed concern that the dollar’s falling value is putting strain on their ability to export.

“We have very much a strong dollar policy … that’s in our nation’s interest. Our economy, like any other, goes through its ups and downs but I believe the U.S. economy will continue to grow and its long-term strength will be reflected in our currency markets,” Paulson told 567 Cape Talk radio.

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Review of Yellen Speech

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(from an interoffice email)

Karim:
Quite a long one http://www.frbsf.org/news/speeches/2007/1203.html, but here goes, with selected excerpts, headings my own.

If you don’t want to read the rest, one word describes it, DOVISH…if she was voting next week, she’d vote for 50bps.

Warren:
Agreed. Though the heightened inflation risks at the end do add some balance. This is far different from the Bernanke and Kohn speeches, and seems this is what they would have said if they held the same opinion.

Conditions are worse from 10/31/07
When the shock first hit, I expected the reverberations to subside gradually, especially in view of the easing in the stance of policy, so that by now there would have been a noticeable improvement in financial conditions. Indeed, though the reverberations have ebbed at times over the last four and a half months, since the October meeting market conditions have deteriorated again, and indications of heightened risk-aversion continue to abound both here and abroad.Mortgages in particularAlthough borrowing rates for low-risk conforming mortgages have decreased, other mortgage rates have risen, even for some borrowers with high credit ratings. In particular, fixed rates on jumbo mortgages are up on net since mid-July. Subprime mortgages remain difficult to get at any rate.Moreover, many markets for securitized assets, especially private-label mortgage-backed securities, continue to experience outright illiquidity; in other words, the markets are not functioning efficiently, or may not be functioning much at all. This illiquidity remains an enormous problem not only for companies that specialize in originating mortgages and then bundling them to sell as securities, but also for financial institutions holding such securities and for sponsors, including banks, of structured investment vehicles—these are entities that relied heavily on asset-backed commercial paper to fund portfolios of securitized assets.

To assess how financial conditions relevant to aggregate demand have changed since the shock first hit, we must consider not only credit markets but also the markets for equity and foreign exchange. These markets have hardly been immune to recent financial turbulence. Broad equity indices have been very volatile, and, on the whole, they have declined noticeably since mid-July, representing a restraint on spending.

Econ Outlook weaker than expected for longer; She’s not mincing words in this section

The fourth quarter is sizing up to show only very meager growth. The current weakness probably reflects some payback for the strength earlier this year—in other words, just some quarter-to-quarter volatility due to business inventories and exports. But it may also reflect some impact of the financial turmoil on economic activity. If so, a more prolonged period of sluggishness in demand seems more likely.

First, the on-going strains in mortgage finance markets seem to have intensified an already steep downturn in housing.

This weakness in house construction and prices is one of the factors that has led me to include a “rough patch” in my forecast for some time. More recently, however, the prospects for housing have actually worsened somewhat, as financial strains have intensified and housing demand appears to have fallen further.

Moreover, we face a risk that the problems in the housing market could spill over to personal consumption expenditures in a bigger way than has thus far been evident in the data. This is a significant risk since personal consumption accounts for about 70 percent of real GDP. These spillovers could occur through several channels. For example, with house prices falling, homeowners’ total wealth declines, and that could lead to a pullback in spending. At the same time, the fall in house prices may constrain consumer spending by changing the value of mortgage equity; less equity, for example, reduces the quantity of funds available for credit-constrained consumers to borrow through home equity loans or to withdraw through refinancing. Furthermore, in the new environment of higher rates and tighter terms on mortgages, we may see other negative impacts on consumer spending. The reduced availability of high loan-to-value ratio and piggyback loans may drive some would-be homeowners to pull back on consumption in order to save for a sizable down payment. In addition, credit-constrained consumers with adjustable-rate mortgages seem likely to curtail spending, as interest rates reset at higher levels and they find themselves with less disposable income.

Moreover, there are significant downside risks to this projection. Recent data on personal consumption expenditures and retail sales are not that encouraging. They have begun to show a significant deceleration—more than was expected—and consumer confidence has plummeted. Reinforcing these concerns, I have begun to hear a pattern of negative comments and stories from my business contacts, including members of our Head Office and Branch Boards of Directors. It is far too early to tell if we are in for a sustained period of sluggish growth in consumption spending, but recent developments do raise this possibility as a serious risk to the forecast.

Net Exports to weaken along with decoupling

I anticipate ongoing strength in net exports, but perhaps somewhat less than in recent years, since foreign activity may be somewhat weaker going forward. Some countries are experiencing direct negative impacts from the ongoing turmoil in financial markets. Others are likely to suffer indirect impacts from any slowdown in the U.S. For example, most Asian economies are now enjoying exceptionally buoyant conditions. But the U.S. and Asian economies are not decoupled, and a slowdown here is likely to produce ripple effects lowering growth there through trade linkages.

Now for the bright side-

I don’t want to give the impression that all of the available recent data have been weak or overemphasize the downside risks. There are some significant areas of strength. In particular, labor markets have been fairly robust in recent months. As I mentioned before, the growth of jobs is an important element in generating the expansion of personal income needed to support consumption spending, which is a key factor for the overall health of the economy. In addition, business investment in equipment and software also has been fairly strong, although here too, recent data suggest some deceleration. Despite the hike in borrowing costs for higher-risk corporate borrowers and the illiquidity in markets for collateralized loan obligations, it appears that financing for capital spending for most firms remains readily available on terms that have been little affected by the recent financial turmoil.

If we cut aggressively, we might grow at trend

To sum up the story on the outlook for real GDP growth, my own view is that, under appropriate monetary policy, the economy is still likely to achieve a relatively smooth adjustment path, with real GDP growth gradually returning to its roughly 2½ percent trend over the next year or so, and the unemployment rate rising only very gradually to just above its 4¾ percent sustainable level. However, for the next few quarters, there are signs that growth may come in somewhat lower than I had previously thought likely. For example, some of the risks that I worried about in my earlier forecast have materialized—the turmoil in financial markets has not subsided as much as I had hoped, and some data on personal consumption have come in weaker than expected. I continue to see the growth risks as skewed to the downside in part because increased perceptions of downside economic risk may induce greater caution by lenders, households, and firms.

Core PCE likely to slow further but still some upside risks

Turning to inflation, signs of improvement in underlying inflationary pressures are evident in recent data. Over the past twelve months, the price index for the measure of consumer inflation on which the FOMC bases its forecasts—personal consumption expenditures excluding food and energy, or the core PCE price index—has increased by 1.9 percent. Just several months ago, the twelve-month change was quite a bit higher, at nearly 2½ percent.

It seems most likely that core PCE price inflation will edge down to around 1¾ percent over the next few years under appropriate policy and the gap between total and core PCE inflation will diminish substantially. Such an outcome is broadly consistent with my interpretation of the Fed’s price stability mandate. This view is predicated on continued well-anchored inflation expectations. It also assumes the emergence of a slight amount of slack in the labor market, as well as the ebbing of the upward effects of movements in energy and commodity prices. However, we do still face some inflation risks, mainly due to faster increases in unit labor costs, the depreciation of the dollar, and the continuing upside surprises in energy prices. Moreover, labor markets have continued to surprise on the strong side. All of these factors will need to be watched carefully going forward.

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