Analysis of the Fed's Decision to Leave Interest Rates Unchanged
Tuesday, August 05, 2008
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SUSIE GHARIB: Joining us now with more analysis, Michelle Girard, senior economist at RBC Greenwich Capital Management and James Awad, chairman of WP Stewart Asset Management. Hi, Michelle. Hi, Jim. Nice to see both of you.
MICHELLE GIRARD, SR. ECONOMIST, RBS GREENWICH CAPITAL MANAGEMENT: Good evening.
GHARIB: Michelle, let me begin with you. Did the Fed do the right thing?
GIRARD: Well, they did what they had to do. Even if there are inflation concerns, this economy is too fragile as are the financial markets for the Fed to address any of those concerns with rate hikes. And so they issued a statement that continued to suggest there are both downside risks to growth and upside risks to inflation and they're going to wait to see which one ultimately wins out. I don't think we're looking at the Fed changing interest rates over the balance of this year.
GHARIB: Jim, what do you think about what the Fed decided to do?
JAMES AWAD, CHAIRMAN, W.P. STEWART ASSET MANAGEMENT: I think they did what they had to do, which is nothing, because they really don't know how long the economic strains are going to remain and they're not sure how long the inflationary pressures will persist or whether they'll subside. So they did what they had to do, which is to do nothing, make statements that there are risks on both sides. So it's very sensible.
GHARIB: Michelle, let's talk a little bit more about what the Fed said about inflation. It said it acknowledged that inflation is high, but it also said that it expects inflation to moderate later this year. So what's the Fed really saying about inflation? Is it a serious problem or not?
GIRARD: Well, they did say (inaudible) it is a significant concern. In June they actually said that the inflation risks had increased and they sort of backed away from that a little bit. So I think that's why the market thought maybe there was less urgency or concern. They clearly wanted to indicate that they are very watchful of it. And, of course, we did have one dissent. There was one member of the FOMC who wanted to actually raise interest rates today.
GHARIB: So what do you see as the next move, Michelle? You said nothing through this year, but is the next move a hike or a cut?
GIRARD: Yes. I think the next move is a hike. I think it won't come until the economy is on stronger footing. I think it probably won't be seen until the spring of 2009.
GHARIB: Jim, what about the market reaction today? We see this explosive reality. Was that more in reaction to the Fed decision or was it because the sharp drop in oil prices? What's your analysis about today and the outlook?
AWAD: Right. Well, I think the first part of the day was oil, which was a continuation of what's been going on lately, which is there is an inverse correlation between the price of oil and the price of equities because oil going down reduces inflation and it's a tax cut. So it was a double positive. And in the afternoon, it was a reaction to the Fed. And I agree with Michelle that the Fed is probably on hold for the foreseeable future. They think their next move is up, but if you listened to Bill Gross today, there are others who think there is an equal chance that it might go down. And I think the markets were positive because the Fed said they expect lower inflation and better growth, but there the Fed I think is talking its book. It's talking about what it hopes the outcome will be, so I think the market probably overreacted a little bit too optimistically today. This is still a work in progress.
GHARIB: Jim, let's say that Michelle is right and the next move is a hike. What does that mean for the markets?
AWAD: Well, actually that would not be a negative because if they're hiking rates they have increased confidence on corporate profits and the strength of the economy and you're hiking from such a very low level, I think actually the markets are in better shape with a hike from here than if they have to lower because if they have to lower, that means we've got real problems in the financial system and that's not an outcome investors would be comfortable with.
GHARIB: Michelle, it's been a year now since this whole credit crisis began. When do you see it ending? Is it too soon to be talking about an end?
GIRARD: I think it is. I think the crisis in the sense of major financial firms that are struggling has probably crested. I think those big writeoffs are going to be beginning to diminish. But I think now the focus is shifting to the smaller banks and financial institutions across the country. They're just not going to be in a position to be making loans for a good while. I think that sort of lingering credit crunch is what's going to keep growth fairly subdued for the next six to nine months.
GHARIB: Do you think Michelle that the economy is in a recession?
GIRARD: It may ultimately get defined that way, but it's very mild. Normally we see payroll declines of near 200,000. We're nowhere near that this time, so it may definitionally be there, but it's very mild. It just feels --it's not an environment that feels very good, whether or not it ultimately gets called a recession.
GHARIB: Jim, what's your timetable on the credit crisis and also the bear market?
AWAD: Well, I think definitely the third quarter and probably the fourth we'll continue to be working our way through these financial problems when you have the issues with Merrill and Lehman and the banks and the contraction of the availability of lending and capital. I don't think you can get an acceleration in the economy this year, maybe next year with some additional stimulus. So I think you're in market with a lot of volatility, no major progress reacting to incoming data. I think there are certain -- it will be a bifurcated market. Companies that are doing well will go up in price. Companies that are struggling will go down in price. And I think the averages are going to stay roughly where they are over the next six months or so and then we'll take a look as we roll into '09.
GHARIB: All right. Thank you both for coming on the program, Michelle, Jim. Always interesting what you have to say.
AWAD: A pleasure.
GHARIB: My guest tonight, Michelle Girard, senior economist at RBC Greenwich Capital Management and James Awad, chairman of WP Stewart Asset Management.
