Why the Fed needs to emphasise inflation not "credit crunch" risks
Simon Ward
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My last post suggested the Fed’s “pre-emptive” rate cuts have been counterproductive. Yesterday’s market action illustrates the dilemma the central bank now faces. A shockingly weak ISM manufacturing report caused market players to discount greater future rate cuts, with some even speculating about a move before the next scheduled FOMC meeting on 30th/31st January. These expectations contributed to a sharp drop in the dollar and a surge in commodity prices, with oil and gold hitting new peaks. Yet higher commodity costs will further squeeze consumer budgets and corporate profit margins, offsetting any support to the economy from lower rates.
The way out of this unproductive cycle is for the Fed to make clear that its primary focus is inflation. Further rate cuts should be made conditional on a stabilisation of the dollar and softer commodity prices. Until inflation expectations moderate, policy easing will continue to have little traction on the real economy.
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