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May 3, 2005

Fed Up

The Fed today did exactly what everyone expected them to do… almost. Their announcement of a new Fed Funds target 25bp higher was no surprise, nor was the continuation of the phrase “likely to be measured” in their reference to future increases. However, The FOMC threw the markets a curve by announcing later in the day that they forgot to include the sentence, “Longer-term inflation expectations remain well-contained.” What their longer term inflations expectations are and what they mean by “contained” will never be known.

What is known is that this group of people is too professional to forget to include a sentence in their statement. I believe the initial omission was as intentional as the later release. Greenspan has a history of trying to talk the markets in the direction he wants them to go (remember “irrational exuberance”), and he simply wanted to make sure the markets focused on this particular sentence. They did, and the market rallied for him. Considering the “correction” came out so late in the trading day, it will be interesting to see if the markets follow through to the upside tomorrow. Either way, Greenspan’s verbal prods have always had successful, yet short-lived, results.

Why, you may ask, does Greenspan want the market to rally? Simply put, he’s trapped, and he’s trying to find an escape hatch. Unless long rates and/or the stock market rallies, he cannot raise short rates much more without risking tipping us into a recession. At the same time, he knows that keeping rates low is a serious threat to the U.S. dollar. So, contrary to popular belief, I do not think that today’s late addition is an indication that the FOMC is looking to halt rates hikes soon. They only want us to interpret the statement that way.

By the way, given a choice between inverting the yield curve or destroying the dollar, the dollar loses. In fact, even if the yield curve reaches inversion, I do not believe the Fed will raise rates enough to adequately defend the dollar. Hence my continued heavy long positions in metals.

Disclosure: None


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