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The Hawks Are Circling

It is unlikely that an increase to the Federal Funds Rate [1] will be announced at the next FOMC [2] meeting on August 5th, but if the Fed decides to hold the line at 2% as expected, this will mark two sessions in a row where the rate was left unchanged. After seven straight reductions – including an unscheduled rate cut – two consecutive holds may signal that we have reached the end of the line with respect to rate cuts. Indeed, recent comments from influential FOMC voting members is seen by some as evidence that a shift in interest rate policy is already in the works.

For the first half of 2007, the FOMC held the federal funds rate steady at 5 ¼ percent but as the credit crunch deepened, the Fed commenced a rate-cutting spree. In addition to the aggressive cuts to the federal funds rate, Bernanke also introduced the Term Auction Facility [3] to help prop up the struggling banking system. Since the first auction in mid-December, the Fed has made over half a trillion dollars available through the Term Auction Facility auctions.

And while yesterday’s Beige Book [4] release indicates little change in overall growth, continued credit worries and surging unemployment (currently hovering around 5.7%) means that it is still too early to break out the champagne. Lost in all this news however, is that the focus now seems to be shifting from the credit crisis to the matter of the jump in inflation.

Inflation for June was pegged at 5.02% – this is an increase of 1.1% from May and is considerably more than the Fed’s yearly projection of 3.4% for all of 2008. This has forced the Fed to up its estimate for annual inflation to 4.2% for the year and even this looks low considering the current rate. While the inflation numbers are high, it is the fact that it is being driven by the basics – energy and food – that makes current results especially concerning. It is difficult for households to make meaningful expenditure cuts to these core items and this means practically everyone is going to be affected by the higher costs.

Weak growth numbers and burgeoning unemployment – combined with spiraling prices – is something we have seen before during the stagflation period of the 1970s [5]. To fight the spiraling prices the country was facing then, Federal Reserve Chairman Paul Volker pushed interest rates up to nearly 20% and kept them there until inflation was truly pinned to the mat; and it was only then that the Fed introduced modest and measured rate cuts. Vilified when they were first implemented, Volker’s actions today are regarded as bold and decisive – and just what was needed for the extraordinary times.

In addition to inflationary worries, there is the ever-present concern with the value of the dollar. The faltering greenback has reduced consumer buying power and this is especially the case for imported goods – and because oil is priced in U.S. dollars, the weaker dollar has also contributed to the increase in the global price of crude. To add to Bernanke’s woes, his counterpart in the European Union – European Central Bank President Jean-Claude Trichet – was quoted on June 25th as saying that the ECB was “on alert” with regards to inflation concerns and an increase in European Union interest rates is a distinct possibility. Also, both China and India (inflation rates of 8% and 11% respectively) are also considering interest rate increases to deal with their escalating inflation.

Any interest rate bump by these countries will further devalue the buck and the more the dollar loses to these currencies, the more costly imported goods become. If these countries do increase their rates, one can’t help but wonder if the Fed would be forced to implement at least a token 25 basis point increase simply to send a strong message to the currency markets.

Interest Rate Hawk or Dove? – The Latest Game Craze

The situation in the U.S. has essentially forced all the FOMC members to become interest rate doves – with the notable exception of hardcore hawks Richard Fisher and Charles Plosser – but if we have truly reached the breaking point, perhaps its time to re-evaluate each voting member to see if they are ready now to assume their true identities. For this, we will look at speeches listed on the Federal Reserve website as well as any recent public statements and the past voting record in a search for clues that might suggest how the member will vote in the future. In the absence of significant comments, we will look at the voting record and judge accordingly.

So, with that in mind, let’s throw out all pre-conceived notions and disregard past reputations. Starting with Big Ben himself, the following table assesses the complete aviary that is the FOMC:

Voting Member Comments Hawk or Dove?
*Chairman Ben Bernanke On July 15th, Bernanke testified that inflation was “too high”. In particular he noted that inflation was much higher than the Fed’s earlier projections and he feared that this would lead to wage and price escalations that could transition simple short-term inflation to long-term inflation deeply-rooted within the economy – essentially what happened during the 1970s energy crisis [5]. In his address to the Committee, he noted that “a critical responsibility of monetary policy makers is to prevent that process from taking hold”.[1] [6]

Record: Voted for each rate decrease.

Moderate Hawk
*Vice-Chair Donald Kohn On June 11th, Kohn told a gathering at the Boston Federal Reserve Bank that “it may be efficient to allow some adjustment period in which both overall inflation exceeds its desired level and the unemployment rate is higher than its long-run sustainable level.”[2] [7]

Record: Voted for each rate decrease.

Dove
*Kevin Warsh Told Washington’s Exchequer Club that the Fed’s use of the “hammer” (i.e. reducing interest rates) has been used to great extent in 2008 but notes that “even if the economy were to weaken somewhat further, we should be inclined to resist expected, reflexive calls to trot out the hammer again”.[3] [8]

Record: Voted for each rate decrease.

Moderate Hawk
*Randall Kroszner Former member of Bush’s economic advisory team with a reputation as a conservative known for supporting open markets and private firms as being superior to government agencies.<ref>Bush Quietly Reshaping the Fed – Chris Isidore, CNNMoney.com Senior Writer, march 3rd, 2006</ref>

Record: Voted for each rate decrease.

Moderate Hawk
*Frederic Mishkin In a presentation to the New York Federal Reserve Bank, Mishkin made it clear that he believes a reduction in interest rates is the best approach to “offset the negative effects of financial turmoil on aggregate economic activity, monetary policy can reduce the likelihood that a financial disruption might set off an adverse feedback loop. The resulting reduction in uncertainty can then make it easier for the markets to collect the information that facilitates price discovery, thus hastening the return of normal market functioning.”[4] [9]

Record: Voted for each rate decrease.

Dove
Richard Fisher – Dallas Federal Reserve Bank Self-confessed hawk – has voted against every rate decrease and actually proposed a rate increase at the June 25th meeting.[5] [10]

Record: Voted against each rate decrease.

Hawk
Charles Plosser – Philadelphia Federal Reserve Bank Also a noted hawk – recently stated that interest rates have been “too accommodative for too long” and that “we will need to reverse course – the exact timing depends on how the economy evolves, but I anticipate the reversal will need to be started sooner rather than later.”[6] [11]

Record: Voted against all but two of the rate decreases.

Hawk
Timothy Geithner – New York Federal Reserve Bank No speeches on the Federal Reserve website addressing interest rates.

Record: Voted for each rate decrease.

Dove voting record.
Sandra Pianalto – Cleveland Federal Reserve Bank No speeches on the Federal Reserve website addressing interest rates.

Record: Voted for each rate decrease.

Dove voting record.
Greg Stern – Minneapolis Federal Reserve Bank No speeches on the Federal Reserve website addressing interest rates.

Record: Voted for each rate decrease.

Dove voting record.

Notes:

  • * indicates a member of the FOMC Board of Governors
  • Comments taken from speeches listed on the Federal Reserve website or as reported in the media
  • Hawk / Dove classification – in the absence of comments suggesting a member’s tendencies, the recent voting record was used to make a determination


References

  1. ↑ [12] Ben Bernanke addressing the Semi-Annual Monetary Policy Report to the Congress Before the Committee on Banking Housing, and Urban Affairs, U.S. Senate – July 15th, 2008
  2. ↑ [13] Address to Federal Reserve Bank of Boston – June 11th, 2008
  3. ↑ [14] Speech to the Exchequer Club in Washington – My 21st, 2008
  4. ↑ [15] Speech at the Feederal Reserve Bank of New York – January 11th, 2008
  5. ↑ [16] FOMC Press Release – June 25th, 2008
  6. ↑ [17] Plosser Says Fed Should Raise Rates Sooner Rather Later – Bloomberg, July 22nd, 2008


About the Author

Scott Boyd has been working in and writing about the financial industry since the early 1990s. As a technical writer and project manager with several of Canada’s leading financial institutions, Scott has produced educational materials for investment system end-users including portfolio managers and traders. Scott now administers and contributes to OANDA FXPedia and regularly provides commentaries for the OANDA FXTrade website.

This article is for general information purposes only. It is not investment advice or a solicitation to buy or sell securities. Opinions are the author’s — not necessarily OANDA’s, its officers or directors. OANDA’s Terms of Use [18] apply.

Scott Boyd
Scott Boyd

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