Despite my quasi-skepticism over the current state of the economy, I highly doubt we will see an increase in interest rates, and particularly after today's CPI report. I do not find the report alarming, even if a 0.6% headline rate of increase will still focus the minds of many on the possibility of inflation. But two factors are still present:

• a good deal of data that many people will use to discount an increase in Q2 GDP, exemplified by today's column from Carolyn Baum;
• the presence of an election year is going to keep many at the Fed a little skittish about being seen as playing a role in the contest. If it is as seen as making a possible recession worse because of pre-emptive tightening, it may face a threat to its independence next year.

James Picerno is correct that the current structure of the FOMC leans towards the hawks, but those hawks will know that if they push interest rates up too fast and move the economy into a longer recession, the next appointments to the Board of Governors will not include many of their species. He quotes three reasons from Thomas Higgins of Payden & Rygel Investment Management that make sense to me:

1. The lower fed funds rate has yet to translate into lower borrowing costs for the average American.
2. The Fed would appear confused and damage its credibility with the financial markets if it were to raise interest rates so soon after cutting them.
3. Higher interest rates would aggravate the pain in the housing market especially given the large number of adjustable rate mortgages that are in the process of resetting to higher interest rates.

Thus Fed policy is likely to stay under the radar as much as it can, leading to a favorable environment for a second-half uptick.

Labels: economics