Quick Take on FOMC Minutes: Letting the Hawks Have Their Day, Raising Downside Risks ~ Steve Blitz Morning Notes
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Thursday, May 19, 2011

Quick Take on FOMC Minutes: Letting the Hawks Have Their Day, Raising Downside Risks

When does the Fed first tighten? We will know the answer by September. By that time the economy will have worked through enough of the current downside risks listed in the most interesting addition to the minutes. To the extent that the recovery is still intact by the fall we could very well see the first steps towards removing monetary accommodation in the fourth quarter. The more interesting question will be whether the Chairman has the support to do something if those downside risks cause the recovery to falter, and what that something would be.

The minutes contain what is, by now, the rather standard argument between the hawks and doves on inflation risk in a high unemployment economy. To me, the more important addition to the minutes is the much broader view on the potential for downside in the economy in the second half of the year:
“While rising energy prices posed an upside risk to the inflation forecast, they also posed a downside risk to economic growth. Although most participants continued to see the risks to their outlooks for economic growth as being broadly balanced, a number now judged those risks to be tilted to the downside. These downside risks included a larger-than-expected drag on household and business spending from higher energy prices, continued fiscal strains in Europe, larger-than anticipated effects from supply disruptions in the aftermath of the disaster in Japan, continuing fiscal adjustments at all levels of government in the United States, financial disruptions that would be associated with a failure to increase the federal debt limit, and the possibility that the economic weakness in the first quarter was signaling less underlying momentum going forward.”

I believe that this view is shared by Bernanke, Dudley and Yellen.

The hawks have the upper hand right now in driving Fed policy; the Chairman, Dudley, and Yellen will have their day again if the economy falters as they fear it will. It seems to me that there is no other rational political way for the Chairman to play his hand.

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