Tuesday, November 01, 2005

Irrational unexuberance 

At breakfast today were three quite smart people -- a CPA, a restauranteur, and a pastor. One of them asked me if the Fed would raise interest rates today. My answer was "bet the farm". All three reacted with alarm and wondered how Greenspan could not get it, that their portfolios were threatened and ability to raise working capital harmed. They were utterly stunned when I said it was a foregone conclusion.

William Polley says the question isn't the increase, it's the language.
"Measured pace"? Probably. Chalk it up to inertia. The phrase has been there so long that it will take compelling evidence that the rate hikes are about to pause. In the last few weeks, that evidence has dried up. Will there be a change in the risk assessment? That's a tough one. On the strength of the GDP report and given the inflation numbers, I think a stronger case can be made for tipping the risk assessment towards higher inflation. But I'm not sure the Fed really wants to put that out there at this point.
I think the information on commodity prices would do it as well. Look at gold or oil, or the CRB index. The price levels remain high. Yet if oil prices were going to continue to rise in the future you'd expect more investment from oil companies, and James Hamilton is quite persuasive that this is not happening. I wonder if that makes him or me an inflation dove?

Here's the point to my three friends, though: The market already expects these rates to continue to rise, with almost 100% probability of a 4.5% Fed funds rate by March. And thus their portfolios will not suffer further from the announcement that should come in an hour or two. As Polley and Tim Duy note, it's what happens after Bernanke takes over that is up in the air.

UPDATE: Tried to publish this at noon, it finally posted at 1:15. And of course now we know they did go up a quarter-point. Polley calls it right on the "measured" language.
The Committee perceives that, with appropriate monetary policy action, the
upside and downside risks to the attainment of both sustainable growth and price
stability should be kept roughly equal. With underlying inflation expected to be
contained, the Committee believes that policy accommodation can be removed at a
pace that is likely to be measured.
And of course Blogger is still being crappy.

UPDATE 2: Money magazine is saying that "the end of 'measured' is at hand." Maybe after the next move in December to 4.25% (I'm moving my chips in now). Bill Polley says 50-50.