Given the Federal Reserve’s cumulative 300bps worth of rate cuts since last September, it is obvious that the FOMC is extremely concerned with the mounting downside risks to growth and the persistent credit crunch that helped to nearly drive Bear Stearns into bankruptcy. However, the minutes of the FOMC’s March meeting revealed that the dissenters in the vote to cut rates by 75bps are growing increasingly hawkish, and there’s a chance that we could see additional FOMC members vote for far less aggressive policy actions in coming months.

Fed: Growth, Credit Markets Still a Problem, Inflation Hawks Take a Stand

Given the Federal Reserve’s cumulative 300bps worth of rate cuts since last September, it is obvious that the FOMC is extremely concerned with the mounting downside risks to growth and the persistent credit crunch that helped to nearly drive Bear Stearns into bankruptcy. However, the minutes of the FOMC’s March meeting revealed that the dissenters in the vote to cut rates by 75bps are growing increasingly hawkish. Indeed, the rest of the FOMC members noted that, despite a recent moderation in CPI reports, there was uncertainty regarding inflation given surging commodity prices. As a result, there’s a chance that we could see additional FOMC members become a bit more hawkish and vote for far less aggressive policy actions in coming months.

FOMC Meeting Minutes from March 18

“Over the intermeeting period, conditions in some short-term funding markets worsened...”

“In the forecast prepared for this meeting, the staff substantially revised down its projection for the pace of real GDP throughout 2008….many other indicators of real activity were more negative....The staff projection showed a contraction of real GDP in the first half of 2008 followed by a slow rise in the second half.”

“Messrs. Fisher and Plosser dissented because, in light of heightened inflation risks, they favored easing policy less aggressively. Incoming data suggested a weaker near-term outlook for economic growth, but the Committee's earlier policy moves had already reduced the target federal funds rate by 225 basis points to address risks to growth, and the full effect of those rate cuts had yet to be felt....They pointed to measures of inflation and indicators of inflation expectations that had risen…Mr. Plosser noted that the Committee could not afford to wait until there was clear evidence that inflation expectations were no longer anchored, as by then it would be too late to prevent a further increase in inflation pressures.

Ben Bernanke, Federal Reserve Chairman (Voting Member)

“Given the exceptional pressures on the global economy and the financial system, damaged caused by a default by Bear Stearns could have been severe and extremely difficult to contain.” – April 3, 2008

“It now appears likely that the real gross domestic product (GDP) will not grow much, if at all, over the first half of 2008 and could even contract slightly.” – April 2, 2008

Richard Fisher, Federal Reserve Bank of Dallas President (Voting Member)

“To say we are falling into the Japan trap, that we are like Japan was in the 1990s, is in my view very misleading. It would be a mistake for us to do now what we advised them to do back then.” – April 7, 2008

Janet Yellen, Federal Reserve Bank of San Francisco President (Alternate Voting Member)

“The economy has all but stalled and could contract over the first half of the year. Starting in the fourth quarter, the economy, at best, slowed to a crawl.” – April 4, 2008

“…economic prospects remain unusually uncertain, and the downside risks to growth are significant.”– April 4, 2008

ECB: Still Hawkish, But Is It to the Detriment of Economic Growth?

The European Central Bank has not backed off from their hawkish inflation bias by any means, and with good reason: CPI remains well above their comfort zone and upside inflation risks persist. Furthermore, ECB President Trichet and ECB Governing Council member Weber remain fairly optimistic that the US slowdown will not take a severe toll on the Euro-zone economy. Indeed, until CPI falls back markedly, the ECB will not even consider cutting rates. However, will it be to the detriment of expansion in the region?

Jean-Claude Trichet, European Central Bank President

“It is obvious that there is a level of resilience in the euro area that has been observed in the first quarter of this year and which has been very visible in terms of industrial production and in a number of other domains including the outstanding credit growth.” – April 7, 2008

Nicholas Garganas, European Central Bank Governing Council Member

“What specifically worries me isn't only that inflation in the euro area has reached an all-time high, but inflation is accelerating from already high levels and the risks to inflation are on the upside.” – April 3, 2008

Dominique Strauss-Kahn, IMF Managing Director
“Global growth forecasts are not really improving. Most of the downside risks identified six months ago have materialized.” – April 7, 2008

Axel Weber, European Central Bank Governing Council Member

“I do not share the vision of the IMF. For the moment we have only seen limited consequences for the euro zone and Germany from the financial crisis in the United States. I do not see any reason to revise the growth forecasts down significantly nor to react through economic policy.” – April 7, 2008

Richard Lee is a Currency Strategist at FXCM.