Bernanke's Pitch: Short Hike to Center
Like many newcomers to another closely followed organization -- Major League Baseball -- Federal Reserve Chairman Ben Bernanke has sailed through "spring training," including a solid performance at his first semi-annual testimony before Congress (see BW Online, 2/16/06, "Bernanke's Happy Honeymoon"). But now it's Opening Day. On Mar. 27, the Fed chief will preside for the first time over a meeting of the central bank's rate-setting arm, the Federal Open Market Committee.
And like the throngs at AT&T Park or Yankee Stadium scrutinizing a highly touted rookie in his big-league debut, all eyes will be on the new guy as the Fed meeting kicks off. The FOMC's rare 2-day March meeting will give Bernanke a chance to meet his colleagues and assess economic conditions. A quarter-point hike in the Fed funds target rate to 4.75% is considered a done deal by Wall Street.
The primary focus for Fed watchers will be the policy statement issued at the close of the meeting on Mar. 28. There's considerable uncertainty over how the post-meeting communiqué will evolve under this new FOMC. Remember, along with Bernanke, there are two other newcomers to the committee, Governors Randall Kroszner and Kevin Warsh.
We suspect the FOMC could erase the statement from Jan. 31 that "some further policy firming may be needed," and replace it with December's "likely to be needed" statement to keep the risks to growth and inflation roughly equal, suggesting future decisions will be almost completely data dependent.
Indeed, recent data could pose some challenges for the Fed, especially after the Mar. 24 release of new home sales data for February. The larger than expected decline on the month reduced market fears of an extended string of rate increases through 5%. While a widely anticipated housing sector cool-down appears to be under way, the overall outlook continues to be positive, given a solid look to first-quarter gross domestic product and a still tame trajectory on the core consumer price index.
Given these factors -- and the fact that Fed funds futures have swung wildly in recent weeks, from showing about 20% probability for a 5.25% rate by the end of second quarter, to the current view of only about 88% risk for a 5% rate by June -- the markets are vulnerable to any hawkish surprises. We think the Fed will do away with its forward guidance and stress the data dependency of policy decisions.
Ultimately, we suspect that the Fed will pull the trigger again in May for another quarter-point increase to 5.0% and then retire to the dugout. Early indications of the March economy suggest that we will see another round of solid employment statistics, and ensuing strength in the production, income, and spending figures for the month. But the outlook for monthly figures is always uncertain, and the Fed will want to open the door to an unchanged stance at the May FOMC meeting, if conditions warrant.