Letter from the Fed

Our economist, Steven Andrew and I visited the Washington Fed and New York Fed last week. Here are Steven’s quick and dirty comments on what we learned from them – written on his Blackberry at Newark airport, so he asks you to be gentle on the terse style.

Some quick thoughts from our meetings with the Fed this week:

The Fed in Washington
Largely upbeat (they’re never anything else). Not genuinely fearing inflation – current communication on this is designed to anchor inflation expectations (seen by Bernanke as top priority – he is far more keen on communicating than Greenspan was, to the extent that he’s introducing a quarterly ‘inflation report’ type thing (it won’t be called that). I haven’t heard this reported in the media yet but Bernanke has definitely charged the Fed staff with setting it up. Bernanke’s arrival apparently has led to lots more work compared to Greenspan’s days. Now seen as a committee of textbook wielding economists (oh dear).

Other changes under Bernanke
More focus on core CPI, more willing to talk about regulating consumer credit (maybe just a sign of the times).

from his testimony this week, Bernanke is clearly no longer happy to declare sub-prime as ‘contained’. The Fed staff we spoke to were naturally reluctant to add much – but said they’d worry more if the risk was still on the banks’ books (rather than in hedge funds and CDOs). Curiously, in my view, there is some optimism that rising equity markets can offset the declining housing market in the ‘wealth effect’ stakes – this from the guy who wrote (with Greenspan) the seminal piece on housing wealth effects concluding that it was many times more powerful than that from equities. Still, I guess the useful thing about these Fed meetings is spotting the bits that don’t add up as the areas most likely to be of concern to the Fed, so this is almost certainly one of them.

Mixed views on this. Why is employment so strong given the collapse in housebuilding? Laying off illegals is seen as having prevented a sharper fall in residential construction jobs, as is some shift to non-residential construction. (Brokers views on this were either ’employment weakness is coming with a lag’ or ‘the statistics are lousy, it’s already happening’).

The Fed is largely untroubled by the employment picture: happy to see the service sector payroll expanding although in truth it’s mostly government, healthcare and hotels (hotel employment and indeed pricing are both very robust, perhaps due to more foreign visitors taking advantage of the weak dollar, and more Americans staying in the country as the same weak dollar makes it too dear to travel abroad). I suspect they’re more troubled than they’re letting on.

The Fed in New York was most bullish. Gloom and doomsters are ‘hobgoblins’ trying to unearth obscure nuggets of bad news. They were dismissive of housing wealth effect. Consumer seen as solid despite recent weakening (because jobs are holding up). Middle America seen as frugal already, not ‘credit obsessed’. High earners are responsible for declining savings rate, so no big deal/correction to undergo.

The Fed isn’t going anywhere until the unemployment rate starts to rise (then I think it would cut rates quite quickly). Labour market data are getting noisier without really showing any proper slippage yet. But it can’t be too far away, in my view. The over-riding focus on inflation is a red-herring/communications device, not a meaningful barrier to lower interest rates if need be.


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