May 25, 2006
TIME TO PUT THE PAUSE ON PAUSE? MAYBE, PERHAPS, POSSIBLY
Today's upward revision in the pace of growth in first-quarter GDP shows the economy expanding at its fastest rate in more than two years. That should give the Federal Reserve something to talk about as it ponders what to do at its next monetary policy meeting on June 28-29.
Bernanke and company keep reminding that they need more data to make an informed decision on the next move (if any) on interest rates. By that standard, can we assume that the Fed is now one step closer to putting the pause on pause and raising Fed funds next month?
Last month, when the first guess of 1Q GDP was dispatched (the "advance" estimate, as it's known), we were told that the economy grew by a robust annualized 4.8%. Today, we learn that GDP was rolling along at a materially faster pace: 5.3%. The "primary" reasons for the upgrade, the Bureau of Economic Statistics says, was a higher increase in inventories and stronger exports that initially estimated.
In any case, an economy growing by 5.3% is an economy that's expanding at a rate that exceeds the current Fed funds rate by more than a trivial gap. Perhaps it's time to rethink if the central bank's monetary policy is at or near a state of neutrality. Even if the Fed were to elevate rates by 25 basis points come the end of June--as it's been doing at every FOMC meeting since June 2004--Fed funds would still be trailing GDP's pace for the first three months of this year.
But as any dismal scientist will tell you, GDP reports--even upwardly revised ones--are yesterday's news, or, more precisely, the previous quarter's news. The question is whether the obviously strong first quarter momentum will spill over into the second quarter and (dare we ask it?) the third quarter? On that all-important question the jury is out, at least when it comes to trying to forge a consensus. And since the first guess at second-quarter GDP doesn't arrive until July 29, the opportunities for conjecture are wide open on matters economic.
Indeed, a contemporary sampling of prognostications suggests no less. For instance, Chris Low, chief economist at FTN Financial in New York, tells Bloomberg News today, "So far, the economic data we've seen for May are shaping up a lot weaker than we expected, and if that continues the Fed can pause."
Meanwhile, David Resler, chief economist at Nomura Securities in New York, this morning writes in a note to clients that his outlook for materially slower economic growth of 3.1% in the second quarter remains unchanged despite today's GDP report.
But another analyst comes leans in the opposite direction, warning that the economy's is in no danger of stumbling. The upward revision in 1Q GDP "helps undermine the recent exaggerated fears in the market that economic growth is slowing sharply," Dick Green of Briefing.com tells BBC News today. "Market fears of a sharp slowdown in economic growth, or even of a recession, are unwarranted."
Recession or expansion may be in the mind of any given beholder for the moment, but Mr. Market is nonplussed with the GDP news. As we write this morning, the 10-year Treasury yield, at 5.03%, is virtually unchanged from yesterday's close. Ditto for the June Fed funds futures contract, which continues to be priced in anticipation that the Fed will keep rates unchanged at the June FOMC meeting.
Perhaps the prudent thing to do is take a page from the Bernanke handbook and wait for more data, starting with the third and final update for 1Q GDP. As fate would have it, it's due for release on the morning of June 29, just a few hours ahead of the FOMC's announcement on interest rates. Is that too small a window of time to influence monetary policy that day? One would think. Then again, perhaps a few hours is all the Bernanke crew needs to rethink a rate decision if the final 1Q GDP imparts fresh and previously unsampled insight. Welcome to the age of monetary policy in real time.
Posted by jp at May 25, 2006 10:14 AM
One would assume that they would plan for a couple of different scenarios regarding possible revisions - i.e. what should we do if the figures are revised this way, by this amount, etc.
That shouldn't be rocket science, but then I never thought that begining draining the excess liquidity in 2004 with 50 basis point hikes would have been either - but it seemed to escape them.
The Confused Capitalist
Posted by: Jay Walker at May 26, 2006 1:41 PM
I agree with the above and while GDP is clearly not the only metric, it is suggestive of further rate hikes. However, I dont think the June Fed Funds futures contract is the correct one to use. The meeting is on the 28th and the contract expires on the 30th. July is the actual contract used for calculating the conditional probablity, which has it a shade below 60% of another 1/4 point hike.
Keep up the good work.
Posted by: Erin Collard at May 25, 2006 1:09 PM