Wednesday, September 14, 2005

A FOMC Meeting Like No Other

The upcoming Fed meeting is arguably one of the most important in a very long time. It will settle alot of bets and change alot of minds. To oversimplify and summarize positions, there is the camp that feels that there is no inflation risk and the Fed has only been getting rates back to levels that are not driven by a panic over deflation. This camp thinks that further rate increases are going to hurt the current expansion, which is fragile, and now even more so after Hurricane Katrina. The other camp thinks that monetary policy has been, and still is, highly accomodative and that the Fed needs to continue to act aggressively to fend off inflation which is patently obvious all around us in the price of oil, gold, housing, and numerous other commodities. Prior to Katrina the latter and the former were about evenly matched, but the devastation on the Gulf coast has given the inflation doves the edge (as has today's core CPI which excludes food and energy [which makes total sense because my family doesn't eat, heat our home or drive anywhere]).

What the Fed does at the end of this month is of keen interest to those that are engaged (with others or with themselves) in a debate over whether we are in a housing bubble or not. I think it will be a decisive moment. The common wisdom has been that low interest rates have fueled the housing boom, which is mostly correct but not a comprehensive explanation. Still I give it alot of weight because it is this common perception that fuels the animal spirits that prevail in the housing market, so it is incredibly important to the housing bubble debate. A corollary is that a sustained reversal in rates has the potential to spook those animal spirits and be what many see as the pin that pricks the housing bubble. Yet home prices have gone from merely nuts to fargin' insane even while the Fed has been raising interest rates since June of last year, because of the view that Alan Greenspan has got to stop raising rates pretty damn soon. In other words, Alan's rate increases have not swayed the animal spirits. They persist on demonizing him as inept or refuse to see how he can't be paying attention to the disappointing payroll numbers, the sporadically disappointing retail numbers and the dreaded 'twin deficits'. Now they have Hurricane Katrina. How can he possibly continue on this course, raising rates, after the the destruction wrought on the Gulfcoast? Doves are even more convinced that rate increases are coming to an end. Katrina represents the crowning star on their tree of complacency. What will happen when the FOMC does raise rates and doesn't soften it's language? What will happen if the FOMC even gets more hawkish towards inflation given that so much production capacity was wiped out and that reconstruction demand will tax already tight materials markets? Will this shock the markets and make the housing bulls think twice about where rates are really headed? I think it has just that potential. September 20 could be an inflection point for the animal spirits that have been driving housing prices up up up.


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