Dallas Fed president Richard Fisher conducted a speech today down south in Mexico, a speech which ultimately sent the mortgage bond market crashing through the floor. He took the opportunity to elaborate on his dissenting vote this last go around.
When the Feds decided to cut rates last week, there was but one vote that was cast against the rate cuts, and Fisher cast it. In his speech today, he informed the crowd why he has turned against further rate cuts and that reason is the one I have been talking about since just after the first rate cut months ago, inflation.
Yet at the same time, we are faced with the unprecedented consequence of demand-pull inflationary forces fueled by the voracious consumption of oil, wheat, corn, iron ore, steel and copper, and all other kinds of commodities and inputs, including labor, among the 3 billion new participants in the global economy. When it comes to these precious inputs, we have no control over the surging demand from China, India, Brazil, the countries of the former Soviet Union and other new growth centers, but we know that it is putting upward pressure on prices in our economy. Economists note that the “income elasticity of demand” for food is higher in China and other emerging economies than in the United States. Many of these countries’ income elasticity of demand for oil and certain other vital commodities is greater than 1, meaning that their demand for these items will increase faster than their income. Even if growth slows somewhat in some of these important emerging economies—the World Bank, for example, projects China’s growth will be 9.6 percent in 2008, down from 11 percent last year—demand for inputs relative to the world’s ability to supply them will likely continue to exert upward pressure on key commodity prices.
We also know that the inflationary expectations of consumers and business leaders are impacted by what they pay for gasoline at the pump and food at the grocery store.
He then says probably the best quote to describe why the Fed should stop and take a look at what it is doing...
Monetary policy acts with a lag. I liken it to a good single malt whiskey or perhaps truly great tequila: It takes time before you feel its full effect. The Fed has to be very careful now to add just the right amount of stimulus to the punchbowl without mixing in the potential to juice up inflation once the effect of the new punch kicks in.
You see, as I have mentioned before, the rate cuts allow the opportunity for inflation to rise out of control. Since the effects of the rate cuts take several months, if not a year, before you see the results, the drastic actions the Fed has been taken recently could fuel the inflationary fire and let it burn out of control. We already have core inflation above the normal Fed "comfort zone". Of course, only time can tell the future, but Fisher is correct in his stance that if nothing else, the Fed should stop reacting (or overreacting) and take more of a wait and see approach.
Since inflation is the archenemy of mortgage bonds, Fisher's comments on the risks of inflation sparked a major sell off in the bonds pit, with bonds dropping as much as 65 basis points, but settling in down 44 at the close. What that means to you is that mortgage rates ticked higher today and broke below their sideways trading pattern allowing the potential for further rate increases down the road.
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