3 Reasons Why the Fed Can Afford to Pause in June

May 20, 2008

Why the Fed Can Afford to Pause

This morning, Federal Reserve Vice Chairman Kohn made the most explicit comment that we have heard from a central bank official to date about pausing in June. He said that the “economy, markets should gradually improve” and “monetary policy appears to be appropriately calibrated for now to promote both rising employment and moderating inflation over the medium term.”

The Federal Reserve needs to pause because inflation is on the rise and they can afford to pause because economic data been stabilizing.

This morning, oil prices hit a new intraday high of $129 barrel, which tells us that inflation will continue to increase.

1. What’s Going on with Producer Prices?

In the month of April, headline producer prices fell short of expectations while core prices rose more than expected. This reversal of patterns is fascinating because the primary driver of higher inflation has been food and energy prices. It isn’t a surprise to see core rise, because prices are being increased everywhere, but I believe that the slower growth in headline prices should be nothing more than a correction within an overall uptrend. The US government has already increased their predictions for food price growth by half of a percentage point and the latest uptick in oil prices will only further increase inflationary pressures.

2. Economic Data Has Been Stabilizing

1. Leading indicators Rose for the Second Month in a Row
2. Housing Starts and Buidling Permits Rebounded in April
3. Manufacturing in the Philadelphia Region is Recovering
4. Service Sector ISM Back in Expansionary Territory
5. Trade Deficit Narrowed in March

3. TED Spread - The spread between what the U.S. government and banks pay to borrow in dollars for three months also dropped to the lowest level in 9 months. This suggests that liquidity problems are easing.

There are still many causes for concern, but for the time being, the Federal Reserve can afford to wait and that will be bullish for the US dollar.

Fed Fund Futures Pricing in a Rate Hike?!

The latest Fed Fund Futures are already pricing in an 86 percent chance that the Fed will leave interest rates at 2 percent on June 25th. The probabilities are the same for rates remaining unchanged in August and September. In fact, the markets are actually pricing in a TINY chance of a rate hike near the end of the year.

Posted in Fed Rate Cut, Fed Rate Cut Expectations, Federal Reserve, Forex, US Dollar, euro