Dow Jones, June 4
Economists at investment bank Merrill Lynch (MER) have abandoned their projection that the Federal Reserve will cut interest rates this year.
The banks shift represents a fairly substantial u-turn in their monetary policy outlook.
After the latest round of data, market action and Fedspeak itself, which has been far more hawkish than we had expected coming off a 0.6% first-quarter growth performance...the Fed is not going to be cutting rates at any time this year, the banks chief economist David Rosenberg, told clients in a note Monday. He explained the central banks current disposition, coming amid five quarters of sub-3% growth, is a clear signal that the Fed does not care so much about what the real economy is doing as much as what the unemployment rate and core inflation are doing.
Indeed, for an extended period the Fed has both in its official communications and in the comments of officials put at the top of the list the effort to get inflation back to more acceptable levels. At the start of 2007, Merrill had expected the Fed would cut rates to 4%. Then, only BNP Paribas was more aggressive, forecasting a 3% year end funds rate. In a survey done on May 4, Merrill had only changed its view modestly, expecting a percentage points worth of easing, to 4.25% by the end of 2007. Merrill Lynchs change in its monetary policy bet puts the bank in better company, relative to the rest of primary dealers, which are elite banks doing business directly with the Fed and who underwrite Treasury debt auctions. A survey done Friday after the release of healthy hiring and manufacturing data, joined with a report showing some easing in year-over-year inflation pressures, found dealers continuing to expect one quarter percentage point cut in the current 5.25% overnight target rate by year end.
That expectation has been holding for some time. But recently, some of the dealers who have expected policy easings over 2007 have pushed back the timing of the move, given incoming data and Fed commentary. Meanwhile, bond markets, once the most enthusiastic endorsers of a Fed easing scenario, have reversed course and are now putting some odds on Fed rate hike by years end. Merrill Lynchs monetary policy projections have in recent years proved problematic. Based on the responses to regularly conducted polls of primary dealers conducted by Dow Jones Newswires, Merrill had the most inaccurate projections of a primary dealer on where the Fed would end 2005 and 2006.
Rosenberg said in his note that Im not going to make a judgment call on whether this is the right policy or not for the Fed to be pursuing. The economist reckons the only factors that appear likely to drive the Fed to ease in 2007 would be a market blowup of some sort, a clear economic slowdown, or unemployment rising from its current level of 4.5% to 5%. Also, if inflation, measured by the personal consumption expenditures price index stripped of food and energy costs slipped to a 1.5% annual gain, from its current level of 2%, that could get the Fed into easing mode, too, the economist said.
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