Watch What the Fed Says, Not What it Does Today

Jun 25, 2008: 10:37 AM CST

Today’s decision will be more about tone than action – about words than a policy decision.

The Fed is expected to keep overnight rates locked at 2%, though some may begin to discuss the threat of inflation on the economy, and may be trying to “jawbone” or threaten action if inflation numbers continue to be unacceptable.

The Fed walks a tightrope today, in that cutting rates would help a struggling economy by making capital easier to borrow, but “lose money policies” can help stoke inflation by weakening the dollar and increasing demand for commodities (in an expansionary environment).

Generally, to ‘tame’ inflation, the Fed will raise interest rates and employ a “tight” money policy, which could restrict access to capital (higher rates equal higher interest payments on loans), but higher rates strengthen the Dollar and help (try to) reduce demand on commodities.

When the Fed is raising rates, typically the Economy can ‘handle’ the reduced access to capital – now, many people believe it is unlikely that it can, and there is a debate across the country as to whether we’re already in a recession, on the brink of a recession, or just slowing down.  Few people can say that “everything is fine and the Economy is firing on all cylinders” anymore.

I wanted to quote a few lines from the article “Watch What the Fed Says…” from CNN Money editor/author Paul La Monica:

“With inflation fears on the rise, there is growing speculation that the Fed may begin to raise rates as soon as its next meeting on Aug. 5. Many economists think that would be soon, however, because the economy is still in a precarious state, and higher rates would kill any chance for a recovery.”

La Monica gives us three specific things to watch for in the speech this afternoon, including:

  1. Bernanke using the phrase, “Substantial Easing and Moderate Growth.”
  2. Bernanke using the phrase “Inflation risks” more times than necessary.
  3. Any discussion about the US Dollar

The market today has already risen strongly prior to the meeting.

Remember that “Fed Days,” even days when “nothing happens,” can be volatile, and often involve an extremely large volatile move up, down, or up then down after the meeting as traders parse through exactly what was said and meant.

Today, parsing his words will be more important than ever before.

For additional reading:

Dr. Steenbarger’s post, Market Views Ahead of the Fed.

Kirk Report:  “Fed Day”

“The first reaction tends to be a false one, but nevertheless with the market looking for something to get us moving again, we should anticipate a sizable move.”

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