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No Satisfaction from the Fed

By Michael Wallace A close read of the tea leaves of the post-meeting statement by the Federal Open Market Committee (FOMC), the Federal Reserve's rate-setting arm, usually reveals a couple of choice kernels of inspiration on future Fed policy. But the June 27 FOMC statement was notable for leaving much unsaid. To some extent the smaller scale quarter-point cut spoke for itself: The end of the easing cycle is approaching. But U.S. financial markets were confounded by a lack of fresh guidance on the policy outlook -- much like the "less filling, tastes great" debate.

Greenspan & Co. cut the Fed funds rate less aggressively to 3.75% and reduced the discount rate by a like amount to 3.25%. By the same token, policymakers stood by boilerplate phrases that profitability and capital spending declines continue to weigh on the global economy. Indeed, the Fed's policy bias remained intact that "risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future."

They also noted, "The associated easing of pressures on labor and product markets are expected to keep inflation contained." Some had also hoped for a hint of an intermeeting move via the fleeting "monitor closely" phrase that had appeared in the past couple of FOMC statements if a smaller cut prevailed, but this was not in the text.

NEARING THE END? Yet the statement was otherwise very lean on detail and justification for the smaller cut than the previous five of this easing cycle. The main noteworthy passage in this very terse statement was a new reference to the cumulative decline of the Fed funds rate, which is the nearest hint that the Fed is nearing the end of the cycle. "Today's action by the FOMC brings the decline in the target federal funds rate since the beginning of the year to 275 basis points," said the Fed.

Fed funds futures, a trading vehicle used by financial pros to bet on the future direction of interest rates, lost ground on the more modest move, with the September contract pricing in only about 65% risk of another quarter point cut. This was down from almost 90% Wednesday, and 100% on Tuesday. And yet the FOMC announcement contained no indication of an end-point to the cycle.

Indeed, risks are still weighted toward the downside and S&P MMS expects another rate cut at the August 21 FOMC meeting. Wallace is a Senior Economist for Standard & Poor's MMS

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