Wednesday, March 21, 2007

Wishful Thinking On Wall Street

If you desire power over other people-then aim at becoming central banker. You don't actually have to do any formal policy action to cause dramatic movements on global financial markets. All you have to do is to delete a sentence in a statement. Watch now how stock- and bond markets in America rallied because the Fed deleted the sentence "additional firming that may be needed" from the statement accompaning the decision to hold the Fed funds rate unchanged. Even though the Fed still explicitly says it is more concerned about price inflation than weak economic growth, the financial markets are now pricing in a 44% chance of a imminent (during the next three months) rate cuts.

Yet with price inflation showing strong upwards pressure, I have difficulty seeing how the Fed could cut rates. Not that I buy into the myth of the Fed as "inflation fighter", but it will be difficult for the Fed to retain that myth if they cut rates in the face of rising price inflation. Since the Fed values that myth so much, they will be unable to cut rates anytime soon.

Update: I see blogger Calculated Risk have a great summary how the Fed in its statements is slowly recognizing how the U.S. economy is becoming more stagflationary, just as I have been saying all along, with both the risk to growth and inflation being greater than in previous statements.


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