Is the Fed Ahead of the Curve?
The overwhelming sentiment of popular market pundits is that the Fed is out of touch and "behind the curve." (One of our hopes for 2008 is that writers will find some other phrases to describe this tired sentiment).
Other Expert Views
Fed policy has an effect with a lag. One way of examining this is to compare Fed action now with policy in past possible recession situations. This method is not used by those pundits whose overconfident view of the future leads them to data supporting what they already see as inevitable.
An interesting contrast is to look at observers who do make this comparison. Two of the very best in recent years have been Dick Green, the CEO of Briefing.com, and David Malpass, Chief Global Economist for Bear Stearns. At "A Dash" we have frequently cited their comments.
Dick Green of Briefing.com has a consistent and sensible approach, that has demonstrated accuracy over several years. He writes as follows:
Enough data is now in to state conclusively: fourth quarter GDP will post a
solid gain. That means the Bernanke Fed began cutting interest rates well ahead
of significant economic weakness. Their early action will help prevent
Green goes on to explain the basic rationale (but follow the link to read the entire article):
The Bernanke Fed has therefore cut the fed funds rate target from 5.25% to
4.25% even as real GDP growth was up at a 5% annual rate in the third quarter
and a 2% annual rate in the fourth quarter.
Furthermore, the Bernanke Fed has taken strong efforts to provide liquidity
to the banking system to address the problems in the credit markets. This is
now starting to pay off. Credit growth has continued, as evidenced in the weekly H.8 data,
and now the prices of mortgage-backed securities appear to be stabilizing, as
reflected in the ABX
David Malpass has a similar view, with similar reasoning. Malpass still sees slowing growth, but rejects the notion of a housing-led recession. His recession odds have been lowered to 20% (which is actually the long-term average for a given year). Malpass wrote on December 21st (you need to be a customer to get this) as follows:
We think the Fed has been unusually proactive – it is now probably at or close to the end of its rate cuts, and will try to use other confidence-building techniques going forward. We think an expression of interest in a stronger dollar would be the most useful, but is unlikely.
This shows his view of the economy, but those wanting more rate cuts will find it discouraging. Malpass explains his reasoning:
We think the Fed has been distinctly more proactive than in past slowdowns. The Fed maintained high interest rates until the brink of recession in 2001 (Fed funds at 6.5% in early January 2001 with recession starting in March 2001) and into the recession in 1990 (Fed funds steady at 8% through October 1990, even though the recession started in August.)
The Fed acted earlier this time, and is also using innovative methods like the TAF auctions.
Many bears highlighted Malpass when he became more pessimistic earlier this year. Doug Kass, for example, called Malpass a "must-read." We are waiting to see what Doug and others say about Malpass’s latest perspective.
The assessment of recession prospects and the Fed reaction has been one-sided. Whether one reads the mainstream media, blogs, or watches financial television, the popular comment is that the Fed has not acted quickly enough. (If only we could collect royalties on "behind the curve.")
At "A Dash" we have tried to emphasize that the Fed is attempting some creative tools in addition to cutting interest rates. Meanwhile, those who have long-standing recession predictions appear to be wrong once again this quarter.
There should be a statute of limitations on these forecasts. The key question for the investor and trader alike remains how much of the "baked in" earnings discount from a recession will actually occur.