US Fed: Can the FOMC Hawks Garner Enough Support For A Rate Hike?

A speech by Philadelphia Fed President Charles Plosser drove the US dollar higher on Tuesday morning, as he signaled that he would be voting to increase interest rates at the next Federal Open Market Committee meeting. That said, Mr. Plosser is one of the most hawkish members of the FOMC, along with Dallas Fed President Richard Fisher, as both dissented in March and April when the Committee cut rates. Can these two hawks garner enough support for a majority vote in favor of an increase to the fed funds rate on August 5?

Charles Plosser, Federal Reserve Bank of Philadelphia President

“Keeping policy too accommodative for too long worsens our inflation problem. Inflation is already too high and inconsistent with our goal of — and responsibility to ensure — price stability. We will need to reverse course — the exact timing depends on how the economy evolves, but I anticipate the reversal will need to be started sooner rather than later. And I believe it will likely need to begin before either the labor market or the financial markets have completely turned around.”

“Since energy price increases have been so persistent in recent years, I do believe more attention should now be paid to measures of headline inflation in setting monetary policy. I don’t believe we can be sanguine that the behavior of core inflation will keep the public’s inflation expectations well-anchored in the face of persistently high headline inflation. To keep inflation expectations anchored means that monetary policymakers will have to back up their words with action.”

Unlikely, as the move would likely ignite an even more severe credit crunch in the financial markets that would only exacerbate the confidence issues plaguing US, European, and British financial institutions – not to mention Fannie Mae and Freddie Mac.

Henry Paulson, Treasury Secretary

“Because of their size and scope, Fannie and Freddie's stability is critical to financial market stability. Investors in our nation and around the world need to know that we understand how important these institutions are to our capital markets broadly, and to the U.S. economy.”

“Turning the corner on the housing correction requires homebuyers to return to the market, and homebuyers need available and affordable mortgage financing. Housing is not only important to our economy; it is also the largest factor currently impacting our financial markets.”

“After consultations with Congressional leaders and U.S. financial regulators, last week I put forward a proposal that will accomplish this in two phases…I would rather not be in the position of asking for extraordinary authorities to support the GSEs. But I am playing the hand that I have been dealt. There is a need to support efforts that strengthen Fannie and Freddie's ability to continue to play their important role in financing mortgages and in our capital markets more broadly.”

“I have asked Congress to provide temporary authority for 18 months to provide a liquidity backstop and a capital backstop to the GSEs. There are no plans to access either of these.”

BOE: Where Will The Divided Monetary Policy Committee Go From Here?

There is a clear division in opinion amongst the members of the Bank of England’s Monetary Policy Committee. David Blanchflower remains by far the most dovish, as he has consistently voted in favor of rate cuts, and it appears that he may be bringing some other members on to his side, namely John Gieve. However, with UK CPI accelerating much faster than previously expected, Mr. Blanchflower may have difficulty getting other members on board, especially as the Bank of England tends to be one of the more hawkish central banks amongst the G8.

David Blanchflower, Bank of England Monetary Policy Committee Member

“I think we are going into recession and we are probably in one right now. We will probably have three or four quarters of negative growth, but the risks are to the downside…It's not too late to stop it, but we have to act right now. Monetary policy has been far too tight for too long. We can't just sit and do nothing as we have done for too long.”

“Our job is to focus on inflation in the medium-term so we have to look through the short-term shock from oil and commodity prices.”

“The economy is now slowing so fast that we run the risk of writing a letter on the low side in the medium-term.”

John Gieve, Bank of England Deputy Governor

“The Monetary Policy Committee will continue to assess the balance between the risks of higher inflation from the commodity cost shock and the downside risks to output (and to inflation in the medium term) from the credit crunch.”

“In setting interest rates we need not just to assess the balance between supply and demand pressures in the economy which will set the context for price and wage decisions in the medium term, but also ensure that our decisions are understood and seen to respond to the economic developments in inflation and output that people are experiencing.”

“More broadly, there are signs that the tightening of credit conditions is beginning to affect both consumption and investment. Most importantly, the sharp increases in commodity prices are squeezing real take-home pay which is bound to impact on consumption at some point.”

Andrew Sentence, Bank of England Monetary Policy Committee Member

“I have been particularly struck by the speed with which inflation has moved to somewhere that is significantly above target. There are clear risks to inflation expectations in this environment.”

“We're facing quite considerable upward pressure on inflation and the traditional response would be 'well, do we need a policy tightening?”

“It's not clear that the slowdown in the economy that has emerged so far is significantly sharper than we were projecting in the May inflation report. I see risks on both sides. We're in a slowdown, there's a risk that it intensifies. At the same time, we have a pickup in inflation and the risk is that that short-term rise in inflation goes further.”

“A slowing economy is part of that process because if the economy wasn't slowing there would be increased inflation risks. The balance of risks has shifted quite a bit over the past few months and may indeed continue to shift.”

ECB: Living in the Past?

It appears that European Central Bank President Trichet is very concerned that the current economic scenario mirrors that of the 1970’s, which explains his renowned focus on price stability. However, with the June PMI reports showing that business activity in the Euro-zone’s services and manufacturing sectors is now contracting, there are mounting concerns that Mr. Trichet may be ignoring important data to the detriment of the European economy.

Jean-Claude Trichet, European Central Bank President

"Our base-line scenario is that we will have a trough in the profile of growth in the euro area in the second and third quarters of this year and, following this, a progressive return to ongoing moderate growth.”

“The latest rise in unit labor costs is a piece of data that we need to take into account. I would certainly not say that second-round effects are currently a general phenomenon. But there are signs that we need to take seriously.”

“In fact our message is that we should prevent second-round effects.”

“The situation is not identical, but I am convinced that there are important similarities…As in 1973-74, today there is a big transfer of income from oil consumers to oil producers.”

“In my view, we have experienced since last August a market correction which is still ongoing and very sizeable, with phases of turbulence, phases of high volatility, and hectic market behavior. This process is continuing.”

“At the same time, we must continuously be very alert.”

Nout Wellink, European Central Bank Governing Council Member

“I am not too cheerful about the economy. But I think it's not terribly relevant.”

“Inflation expectations are changing for the short term. Those for the long term are still stable and low. We have to prevent long-term expectations changing. It's a mistake to think that inflation will fall if the economy weakens. We have seen that too in the 70s. If you don't act, you get high inflation and low growth, stagflation.”

Vitor Constancio, European Central Bank Governing Council Member

“There are signs that the European economy has already begun to slow down, possibly very significantly.”

“It isn't fair to say that if the goal of monetary policy is to control inflation, one should ignore the development of the real economy.”

“Under normal circumstances, a rise in the interest rate by the ECB would have resulted in higher medium-term rates and a higher euro. Well, the exact opposite happened.”

Richard Lee is a Currency Strategist at FXCM.