Monday, July 21, 2008

‘Whac-A-Mole’ is not Working

FOMC Report
March 18, 2008





‘Whac-A-Mole’ is not Working
…Restart ‘Measured Pace’






Martin B. McGuire
(Chicago)
When we get to the point where the market is pricing as much as a 33% reduction in the fed funds policy rate from 3% to 2% at the upcoming meeting, we know these are not the best of times.

It is a most difficult task to accept that the economy has arrived at the point where our studies had indicated. I am asked more often now if I think we are going into a recession and my reply for weeks has been that we are likely already in a recession. It is difficult at this stage not only because we see many struggling, but because it is our nature to try to look through the current funk and anticipate a more immediate recovery. Certainly every economic downturn since the early 1980’s has been so mild and brief that we have been conditioned to see through to the other side.

There is certainly reason to entertain theories of how the current financial market backdrop might improve and the deteriorating economic prospects might reverse. However, as economists, market watchers and traders, we would do well at this juncture, if we were so blessed, to enjoy to the extent allowable the fact that we had correctly anticipated and took measures to benefit from the movement toward the current state of affairs.

Let us then not be too smart in trying to find the next grand notion that will move us away from what we had anticipated. Rather, with mature countenance we should remain patient and watchful in the unfolding of continued financial dislocation and deteriorating economic conditions. This for some is much more difficult than having been right in expecting the unfolding of the disaster which we are living through.

Making a Case for Measured Pace Language

If the Fed eased 75 to 100 basis points tomorrow on March 18 and follows up in the accompanying statement that they intend to continue to move monetary policy to a more accommodative position at a ‘measured pace’ they may succeed in truncating the current credit crunch.

Market participants already know what ‘measured pace’ means, which is 25 basis points at the next FOMC meeting, so there will be an extreme amount of comfort, afforded the known Federal Reserve policy path. As a result, volatility will be tempered and a threat of normalcy will invade. In effect, the Fed will be giving the market visibility by showing a longer piece of the policy rates time line than market participants currently can envision. This then would reduce the dominant level of uncertainty and allow for calmer heads to prevail.

Current Fed Rate Expectations:

FOMC Date Funds Target Risk Assessment

March 18, 2008 2.25% Slow Economy
April 29-30, 2008 2.00% Slow Economy
June 25, 2008 1.75% Slow Economy
August 05, 2008 1.50% Slow Economy
September 16, 2008 1.50% Balanced
October 29, 2008 1.50% Balanced

End

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