By William Patalon III
Money Morning/The Money Map Report
Just one day after Money Morning predicted that the U.S. Federal Reserve would soon be forced to increase interest rates, Dallas Fed President Richard W. Fisher said he expected the central bank would raise interest rates should inflationary pressures start causing severe consumer pain.
"If inflationary developments and, more important, inflation expectations continue to worsen, I would expect a change of course in monetary policy to occur sooner rather than later, even in the face of an anemic" U.S. economy, Fisher said during a Wednesday speech in San Francisco.
In a financial commentary titled, "With Oil Speculators Blitzing, the Fed Needs to Call an Interest-Rate Reverse Play," Money Morning Contributing Editor Martin Hutchinson predicted that escalating inflationary pressures will force central bank policymakers to start increasing the benchmark Federal Funds rate – perhaps as soon as the two-day Federal Open Market Committee (FOMC) meeting that's scheduled for June 24-25.
Although the article was datelined Wednesday, Money Morning's articles are typically posted to the Web site the night before. And Hutchinson actually filed the article on May 21 – a full week before Fisher made his comments. Even before that, however, Hutchinson has repeatedly warned that inflation was becoming problematic: Back in early April, he even predicted that gold prices are headed for the $1,500-an-ounce level – again, due to inflationary pressures [Check out several of Hutchinson's recent inflation-related research reports – one detailing profit plays stemming from higher oil prices, and the other looking at gold plays. Both reports are free of charge].
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A move to boost interest rates would be a major story as well as a major turnabout for the U.S. central bank. After all, for nearly eight months the Federal Reserve has been engaged in one of the most aggressive rate-cutting campaigns in its history, having slashed short-term interest rates from the 5.25% level in mid-September down to 2.0% today.
The Fed Funds rate is the interest rate Fed-member banks charge for overnight loans to other institutions needing the cash to meet reserve requirements. Changes in that rate quickly affect borrowing costs throughout the U.S. economy, since commercial lenders are quick to adjust the so-called "Prime Rate" – and rates on other types of loans – in lockstep with changes in the Fed Funds rate.
Hutchinson, a longtime international banker and an expert on emerging-markets finance, said that as soon as he read, he knew a near-term rate increase was likely. The two key reasons:
- The central bank had reduced its 2008 economic growth outlook from the range of 1.3% to 2.0% it issued back in January down to a new, lower 2008 growth estimate of 0.3% to 1.2%.
- At the same time, FOMC policymakers boosted their estimates for inflation – excluding food and energy prices – to a range of 2.2% to 2.4% this year, up from an earlier range of 2.0% to 2.2%.
According to Hutchinson, that double-whammy of lower growth and higher inflation leads to only one conclusion: Interest rates must head higher.
"Obviously, the Fed's outlook on growth and inflation both changed," Hutchinson said in a telephone interview from his Washington-area home yesterday. "There's a lot of straw in the wind at this point."
The April FOMC meeting minutes were released May 21; Hutchinson wrote his analysis and made his predictions later that same day. Prior to the release of the Fed minutes, there was almost no marketplace expectation of a near-term increase in interest rates.
Over the past few weeks, several other Fed bank presidents – including Thomas Hoenig of Kansas City and Gary Stern of Minneapolis – have displayed an escalating concern about spiraling pricing pressures. But Fisher, 59, is the only FOMC policymaker to "dissent" three times from decisions to lower the Fed Funds rate, Bloomberg News reported.
Fisher either wanted to see less-aggressive actions, or no changes at all to interest rates.
"I don't know a single person on the committee that isn't concerned about inflation," Fisher told reporters immediately following his Wednesday speech to the Commonwealth Club of California. "The question is, 'what is the right treatment? That is subject to debate.'"
In his speech, Fisher said he expects the Fed will raise rates should the public expectations of higher prices begin to surge. And the combination of higher inflation and slower growth bodes poorly for the U.S. economy.
U.S. consumers are "in for a period of anemic economic activity [that probably will last] for awhile," Fisher told journalists after the speech. And then when the economy quickens, the U.S. may be "encumbered by a higher rate of inflation than we ordinarily would like to have."
According to the April Fed meeting minutes, most FOMC members viewed last month's rate cut as a "close call." Along with Fisher, the meeting records show that Philadelphia Fed President Charles Plosser wanted the central bank to stand pat on rates, citing the "more worrisome development" in inflation.
Going forward, Money Morning's Hutchinson says one additional recent development further buttresses his prediction of an interest-rate increase by the Fed: On Wednesday, Federal Reserve governor Frederic Mishkin announced that he's leaving the central bank Aug. 31 to return to teaching at Columbia University's Graduate School of Business. A member of the Fed's board of governors since Sept. 5, 2006, Mishkin was part of the "soft money crowd," who advocated lower rates, and who might therefore oppose a move to raise them anew, Hutchinson says.
Given that, Hutchinson says that a Fed Funds increase of a quarter to a half-percentage point is possible at one of the next two meetings – the one in June, or the next one in August.
Futures traders expect the Fed to hold off on further rate cuts this summer, and to start raising rates in the fall. Futures contracts price in a 4% chance of an additional rate cut when the Fed meets in late June and a 56% chance that FOMC policymakers will opt to boost the Fed Funds rate by a quarter point to 2.25% when they meet in late October, MarketWatch.com reported.
Despite the shift in expectations among institutional investors, a continued escalation in crude oil and gasoline prices has kept alive the threat of inflation.
Needless to say, Money Morning will continue to watch market changes, and will keep you informed of our expectations.
News and Related Story Links:
- Money Morning Financial Commentary:
With Oil Speculators Blitzing, the Fed Needs to Call an Interest-Rate Reverse Play.
- Bloomberg News:
Fed Should Increase Rates If Inflation Accelerates, Fisher Says.
- The Federal Reserve Bank of Dallas:
Storms on the Horizon: Remarks before the Commonwealth Club of California (in) San Francisco, California, May 28,2008.
- Bloomberg News:
Fed governor Mishkin resigns effective Aug. 31.
- Money Morning Special Investment Research Report:
Six Ways to Play Money Morning's Prediction That Gold is Headed for $1,500 an Ounce.
- Money Morning Special Investment Research Report:
As Oil Prices Hit Another Record High, Consider These Three Ways to Profit From This Long-Term Gusher.
Fed's Fisher sees rate shift even if growth weakens.
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.