As we know the Federal Reserve cut rates by 0.25% on Wednesday to bring the Fed Fund rates down to 2% with the discount rate also cut 0.25% to 2.25%. Of more interest though was the accompanying statement, especially when compared to the release made in March after the 0.75% cut.

Here we go then, let us compare the two statements, paragraph for paragraph and see where the Fed has changed its outlook and get some clues as to what it expects to happen in the future. I will reproduce the March 18th paragraph first and then the April 30th version, with my comments following.

• March 18thThe Federal Open Market Committee decided today to lower its target for the federal funds rate 75 basis points to 2-1/4 percent.Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened. Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.

• April 30thThe Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2 percent.Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.

This is a subtle but important change of emphasis in the April statement. It is no longer the outlook for economic activity, this is a reflection of current conditions and a confirmation that activity did weaken, a downside risk that came to fruition. The Fed kindly shows which part of the economy is now suffering, with the emphasis placed on household and business spending.

As subscribers to An Occasional Letter saw in the latest edition, this comes as no surprise and points to a failure of the Fed/US Govt policies to rectify the damage caused by the credit crash. This is a recessionary, deflation biased outlook from the Fed.

• March 18thInflation has been elevated, and some indicators of inflation expectations have risen. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully

• April 30thAlthough readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.

This is a flat out dangerous approach to the Feds inflation fighting credibility. As you can see, the Fed acknowledges that core inflation has improved of late but then goes immediately off message by including non core items in its assessment of inflation expectations. This is a policy shift of some importance. Is the Fed becoming desperate in its attempts to foster a credible inflation fighting stance whilst allowing rates to fall, encouraging inflationary tendencies? Without a doubt. The fact that the Fed expects inflation to moderate in “coming quarters” is not an effect of policy but just a reflection that the previous year’s acceleration in the price inflation rate will fall back, thus the rate of increase slows.

Notice the “uncertainty” is still mentioned. This is to help the Fed nurture the expectations of inflation it requires to allow its policies to continue. What they don’t say is the uncertainty about the inflation outlook is not a one way street. I suspect the Fed is more worried about downside risks to inflation than upside.

• March 18thToday’s policy action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will act in a timely manner as needed to promote sustainable economic growth and price stability.
   

• April 30thThe substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.
   

The important change is the way the Fed accounts for its actions. “Today” is replaced by “to date”. It is a culmination, a totaling up of the actions taken since last summer rather than a mention of an ongoing policy. There is also a relaxation in the stance of the Fed. No longer is a “timely manner” required. From now on the Fed will only act “as needed”.

The Fed is back to watching for changes in data rather than reacting to current events, a return to its pre-summer ’07 position. Market expectations of further cuts should now be treated cautiously, the Fed has returned to the old style of keeping the market guessing.

There is one further message in the statement and I believe it is directed at the US Treasury and Government. The Fed is telling them it has done all it can to alleviate current economic malaise and has decided that responsibility for further stimulus no longer lies within its remit.

The Fed has changed monetary policy so that a direct fiscal delivery of cash and credit can be delivered with maximum effect. Eyes should now be turning toward the politicians to see if they can produce the goods.

Commentary by Mick Phoenix

on behalf of CA Letters

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