Analysis of the Fed's Refusal to Raise Interest Rates
Tuesday, August 08, 2006
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SUSIE GHARIB: Joining us now for more analysis of today`s Fed decision to hold interest rates steady, Michelle Girard, senior economist at RBS Greenwich Capital Management and Hugh Johnson, chairman and chief investment officer of Johnson Illington Advisors and welcome both of you.
MICHELLE GIRARD, SENIOR ECONOMIST, RBS GREENWICH CAPITAL MANAGEMENT: Hi Susie.
HUGH JOHNSON, CHMN., & CHIEF INVESTMENT OFFICER, JOHNSON ILLINGTON: Thanks.
GHARIB: Michelle, let me start with you. So was the Fed`s decision today a pause or is this the end of rate raises?
GIRARD: Well, they clearly signaled it was a pause. They retained the language that they had used in June, saying as you noted that there are still some upside inflation risks and that the Fed will take whatever steps are necessary to address those risks if the incoming information suggests that that`s necessary. So the door is still open for further rate hikes. I think it would be a little premature to assume at this point that the Fed is finished just because they didn`t move today.
GHARIB: Hugh, what do you think? Is the Fed done?
JOHNSON: I think they`re going to be done, but they certainly didn`t say. As Michelle suggested, they didn`t say that they`re going to be done. They left that option clearly open by simply saying the risk of higher inflation certainly still exists and if we do see higher inflation, if the incoming numbers tell them that the outlook for the economy and inflation particularly inflation is a little bit darker, then they won`t hesitate to raise interest rates. They`re taking a real bet here, Susie that the economy is indeed going to continue to slow and the rate of inflation is going to come down. But if that`s not the outcome, they`ll raise rates.
GHARIB: And what`s your interpretation of what happened in the markets? You think that now that the Fed stopped raising rates, that there will be a market rally. We saw the Dow jump after the announcement and then it went into negative territory. Why the volatility today?
JOHNSON: In my judgment, Susie, this had to do more with the bigger issue that investors are facing, and that is, are we headed towards a soft landing, just a slow-down in the economy or a hard landing? Another way of saying it is the combination of the rate increases we`ve already seen, higher oil prices, the slowdown in housing, going to lead to a hard landing or recession in the economy or not? That`s what investors are primarily worried about. What the Federal Reserve did today really doesn`t answer that very big question. That still lies ahead of us.
GHARIB: Michelle, the Fed said in its statement that inflation pressures seem likely to moderate. Is the Fed right about that in your view?
GIRARD: I think we`re going to continue to see upward inflation pressures but remember, inflation tends to lag. So in the Feds` mind, as long as the economy is moderating, then looking ahead, they`re confident that inflation will follow suit. Now I guess where I disagree most is the fact that I don`t think the economy is going to weaken quite as much in here I think as the Fed does. I actually think that in six weeks` time when they meet again, the economy is going to look firmer and so I think they`re going to take action in the September meeting. But it`s mostly going to, you know, what the Fed does is going to be based on how the economy looks and I don`t think it`s as weak as they think.
GHARIB: So Michelle, to you again, is today`s Fed decision good news for bond investors?
GIRARD: Well, you know, the bond market is looking at the signs of a economic slow-down and as Erika pointed out in the package, they`re already thinking next cut, next move could be a cut. The market always tends to go further and faster I think than reality and I think there`s probably going to be the reassessing of that optimism about the Fed being done if indeed we get the stronger economic indicators that I think.
GHARIB: Hugh, are you reassessing? Are you reassessing your investment strategy given what happened today?
JOHNSON: Not what happened today but based on what the markets have been signaling since the beginning of May and they`ve been signaling just what`s happening and that is that the economy is in the process of slowing, perhaps and I kind of disagree with Michelle on this. Maybe it`s going to slow more than is currently widely forecast. Earnings are going to slow and based on the message I`m getting from the markets, Susie, I`ve been sort of taking the defensive side, reducing my allocation in stocks just a little bit, shifting to the safer sectors and emphasizing larger, safer companies as opposed to small cap stocks. So I`m moving slightly to the defensive side based on the markets.
GHARIB: Real quickly, Michelle, we have little time left. I want to get your view on this dissention on the vote today. Is this a sign that there`s a debate brewing inside the Fed and that there is some dissention coming up in future meetings?
GIRARD: Well, there`s debate and that`s always the case when you`re getting near the end of the cycle. Some people think you need to go further. Others want to stop and assess. So I don`t really think it was that significant. We`ve known that there`s been some debate and I think all that we saw today was evidence of that.
GHARIB: All right, Michelle, Hugh, thank you so much. We appreciate you coming on, giving us your analysis.
JOHNSON: Nice to be with you.
GHARIB: We`ve been speaking with Michelle Girard, senior economist at RBS Greenwich Capital Management and Hugh Johnson, chairman and chief investment officer of Johnson Illington Advisors.
