Thursday, February 09, 2006

The Fed Is Over Doing Rate Hikes

Based on our January survey of purchasing mangers in 12 states, I expect inflationary pressures to continue to weaken over the next few months despite higher oil prices, as the Fed’s 14 rate hikes since June 2004 begin to have their intended effect of slowing inflation and growth in the economy.

While the overall index from our survey rose, confidence among supply managers and business leaders in the region declined to 59.7 for January from December's more optimistic 61.9. It may be that the closing of the Japanese border to U.S. beef again in January reduced the economic outlook among survey participants. As we have seen in the past few months, our inflation gauge, and most national inflation indicators, point to somewhat lower inflationary pressures ahead. Despite this trend, the Federal Reserve Open Market Committee (FOMC) raised interest rates at its meeting on January 31. While this was expected, I was surprised by the FOMC’s accompanying statement, which pointed to another rate hike at their next meeting on March 28. The most recent rate increases, and a rate hike at its next meeting, in my judgment, will slow growth to an unacceptably low rate for the region and the nation.

The U.S. Bureau of Labor Statistics job report issued on February 3 was very bullish with almost 200,000 jobs created in January. On top January's solid additions, the BLS revised upward November and December job gains. Thus, the market is now pricing in several more rate hikes. Unless we get some very negative economic news between now and March 28, there is an almost 100 percent likelihood of a rate increase on that date. I think the market can effectively deal with this increase but with much slower growth in the second half of 2006.

Short term rates are now higher than long term rates, termed an inverted yield. Over the last two decades, the U.S. economy has posted 3 inverted yields, each followed by a recession. While I am not projecting a recession, I do anticipate growth that is unacceptably low for the second half of 2006.



James said...

"While I am now projecting a recession, I do anticipate growth that is unacceptably low for the second half of 2006."

Mis-type or is this truly your projection?

Ernie Goss said...

Thanks James for pointing out my significant error. I have corrected it.

Ernie G.