Thursday, September 21, 2006

THE SHORT VIEW By John Authers - Judging by their reaction, traders found yesterday's Federal Reserve statement disappointing.

THE SHORT VIEW By John Authers
Copyright The Financial Times Limited 2006
Published: September 21 2006 03:00 | Last updated: September 21 2006 03:00


Judging by their reaction, traders found yesterday's Federal Reserve statement disappointing. It is hard to see what they were hoping for.

The Fed left the Fed Funds rate unchanged at 5.25 per cent, as universally expected. But the accompanying statement stayed almost unchanged and that came as a surprise. Sentiment during the morning was that the Fed would change its wording to give a clear nudge towards the doves who want interest rates to go down, rather than the inflation hawks.

Had the Fed been that unequivocal, it is possible that the Dow Jones Industrial Average would have hit an all-time high. As it was, the S&P 500 reached a five-year high in the morning, only to slip a little once the Fed's words were known. The dollar strengthened against the euro and the yen, while the Treasury market, the most bullish about the prospects for rate cuts, gave up its morning gains.

This reaction seems to confirm that the markets, particularly bonds, had got ahead of the Fed. There are arguments either way. Signs of inflationary pressure persist, while the only clear sign of a slowdown comes from the housing market. But the balance of probabilities, after this statement, points clearly towards the doves.

To maintain credibility, the Fed, like any central bank, had to stress its watchfulness on inflation. Given this eternal verity, the governors moved the statement in about as dovish direction as they dared. The "cooling" in the housing market is no longer described as "gradual," as it was in August. And, on a day when falling oil prices briefly brought Brent crude below $60 per barrel, it said inflation pressures seemed likely to moderate, "reflecting reduced impetus from energy prices". The oil price correction is thus presented as a point for the doves. This is true of headline inflation, which includes energy prices.

But the fall in oil is more a point for the hawks: cheaper petrol should free consumers to spend more and push up "core" inflation, which matters more to the Fed. The positive gloss on the oil market made this Fed statement about as good as the market should have expected.

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