US Fed: Cautious on Growth Prospects, Focused On Inflation

Much of the US dollar’s gains since mid-July have come as the result of market expectations that the Federal Reserve will raise rates in an effort to fight inflation. Indeed, many of the Federal Open Market Committee members remain openly hawkish, but growth is still a clear concern as well. Furthermore, with the US government’s seizure of Fannie Mae and Freddie Mac, it is obvious that the credit crunch is worrying to everyone. Nevertheless, the US Treasury was really the one to lead the charge in the GSE (Government Sponsored Enterprise) intervention, suggesting that the Federal Reserve will not make any other efforts to address liquidity issues beyond their existing lending facilities. Indeed, the future direction of the fed funds rate will likely be a hike, but given the downside risks to economic growth, don’t expect such a move until 2009.

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

"Two weeks ago, I spoke in Aspen and described the current domestic economic predicament like this: The housing market has yet to find its bottom; credit markets remain tempestuous; creditors are tightening their standards; consumers and businesses are battening down the hatches and reefing in their sails. The prices of Chinese and other emerging country labor and inputs we have come to depend on have been rising; business margins are being squeezed; consumers are suffering from declining real incomes; savers and investors are confronted with negative real rates of return. These are hardly fortuitous circumstances...I see nothing on the horizon that would lead me to conclude anything different than what I articulated in Aspen."

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

“While one might be tempted to interpret the recent strong numbers as a sign that things are turning around, there are three important reasons to think that the strength will not hold up, and that economic performance will be decidedly subpar in the second half of the year…Overall I anticipate that real GDP growth in the second half of this year will come in below growth of potential output which implies that the unemployment rate will rise.”

“Even though the rate of decline of house prices has shown signs of moderating, it still appears that these prices will keep heading down for some time…My guess is that market functioning will improve in 2009, but things could get worse before they get better.”

“Headline inflation is likely to remain much higher than I would like for a quarter or two as previous increases in commodity prices boost the prices paid by consumers for food and energy. With regard to core inflation, I wouldn't be surprised if it runs modestly higher for a while, too, as businesses pass on some of their higher energy, transportation, and other costs to customers.”

ECB: Lest You Forget, Hawks Abound in the Euro-zone

The European Central Bank left rates unchanged at 4.25 percent last week, and as expected, ECB President Trichet remained hawkish on inflation and somewhat bearish on economic prospects, especially since ECB staff projections for growth were revised down for 2008 and 2009. Overall, though, ECB voting members remain focused on their primary mandate of price stability, suggesting the 25-50bps worth of cuts expected during the next 12 months will not occur until 2009.

Jean-Claude Trichet, European Central Bank President

“…the annual HICP inflation rate is likely to remain well above levels consistent with price stability for quite some time, moderating only gradually during the course of 2009.”

“On the basis of our assessment, the current monetary policy stance will contribute to achieving our objective.”

“…ECB staff macroeconomic projections for the euro area projects average annual real GDP growth in a range between 1.1 percent and 1.7 percent in 2008, and between 0.6 percent and 1.8 percent in 2009. In comparison with the June Eurosystem staff projections, real GDP growth figures for 2008 and 2009 are lower.”

Juergen Stark, European Central Bank Executive Board Member

“Recent modest declines in oil and other commodity prices from the peaks seen in mid-July suggest some moderation in external pressures, provided that these declines are sustained. However oil and food prices remain significantly high and above their average 2007 levels, being the main driving forces for inflation in most regions of the world."

“For the second half of the year, however, retreating leading indicators and survey measures suggest a somewhat more pronounced global slowdown. In particular, global economic prospects continue to be shaped by the US economic outlook, which is subject to high uncertainty in view of the ongoing corrections in both the financial and housing markets.”

Ewald Nowotny, European Central Bank Governing Council Member

“The price bubble has burst or is about to burst in a number of raw materials markets, which means we now have the opportunity, the possibility of low inflation rates."

“We have a trend, we have a tendency that it is going downwards…But one always needs to point out that the inflation rate is still far too high in its overall level, which means there is no reason whatsoever to give the all clear.”

“The ECB should continue the policy of (a) steady hand with regards to inflation…The general assessment is that there are significant downside (economic) risks.”

Jose Manuel Gonzalez-Paramo, European Central Bank Executive Board Member

“The ECB has an obligation to act against inflation to maintain its credibility…Levels of inflation above two percent in the medium term are not compatible with price stability. You can deduce from that what you like. The ECB will do at every moment what is necessary to guarantee price stability, you can be sure of that.”

Antonio Sousa is a Currency Analyst for FXCM.