From the July 01, 2011 issue of Futures Magazine • Subscribe!

Fed tightening: What’s the rush?

Market Watch

imageA tightening of the Federal Reserve’s ultra-easy monetary policy is drawing nearer, but that doesn’t mean it is close.

At their April 26-27 Federal Open Market Committee (FOMC) meeting, Fed policymakers had an extensive discussion of how to "exit" eventually from a policy that has kept the federal funds rate near zero for 2-1/2 years and ballooned the central bank’s balance sheet to $2.8 trillion.

But as FOMC minutes stipulate, "The Committee’s decision to discuss the appropriate strategy for normalizing the stance of policy at the current meeting did not mean that the move toward such normalization would necessarily begin soon."

Fed funds futures are not pricing in the initial 25-basis-point rate hike until well into next year, and the Fed has done nothing to disabuse market participants of that sense of timing.

True, Minneapolis Federal Reserve Bank President and FOMC voter Narayana Kocherlakota has called for raising the funds rate by 50 basis points before the end of the year, but only under certain assumptions — that core PCE inflation continues to run at the 1.5% first quarter pace and that the unemployment rate fall to 8-8.5%. If inflation falls, he says the Fed would need to "ease further."

Other voting Fed presidents have been less assertive. Chicago’s Charles Evans says he can’t imagine circumstances that would justify a monetary tightening this year. Not even hawkish Dallas Fed President Richard Fisher sounded eager to start withdrawing monetary stimulus when I interviewed him recently. "I think the question is one of timing. It depends on economic developments. I’m on the hawkish wing, but we have to wait and see what data ensues," he says.

Fisher also cautioned the Fed mustn’t "overreact to inflation."

Similarly, Philadelphia Fed President Charles Plosser, another voting "hawk," has been vague as to when the Fed should start any sort of tightening — beyond saying, "If the economy continues to make progress, then monetary policy will need to exit from its extraordinary accommodation in the not-too-distant future."

"As to when to begin exiting from accommodative policy, I will continue to look at the data on output and employment growth and on inflation and inflation expectations," Plosser says.

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