Reply #24: Dollar`s Lucky 11 as Alan Shrugs Katrina [View All]

[54anickel]

http://www.forexnews.com/AI/default.asp

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The fact that the Fed deems “core inflation has been relatively low in recent months and longer-term inflation expectations remain contained” despite the surging volatility in energy prices, means the central bank is highly confident of the accommodative role of its overall monetary policy.

Indeed, despite the 11 rate hikes of the past 15 months, liquidity remains plentiful. The red graph in the chart below shows that the month-to-month increase in money supply (M2) stands at a relatively modest 0.2%, but is well above its April lows of -0.1%, suggesting the Fed is raising liquidity to offset the effect of rising interest rates and mounting fuel prices. This clearly suggests that Fed’s tightening campaign is aimed at normalizing interest rates towards a neutral level—most likely at a 4.00%-4.25% fed funds target, but without hindering economic growth, hence, maintaining an “accommodative” policy via generous M2 liquidity.



Moreover, our rationale for a pause in monetary policy is underlined by the emerging of a slowing US consumer in the 2 years preceding the Hurricane. The next chart shows that the contribution of US consumers and companies into GDP growth to have slowed invariably. The slowdown in consumers' contribution to GDP from 4.1% in Q3 2003 to 2.1% in Q2 2005 occurred well before the 30% increase in gasoline prices between July and mid September. Falling consumer confidence (tumbling Univ of Michigan), increased jobless claims and unemployment which are not guaranteed to be filled are factors that are cause for a Fed pause. It may be argued that a Fed pause today might have run the risk of bringing the Fed it behind inflation especially that there is no scheduled meeting in October. But as we argued over the past year, the contractionary risks of higher oil are increasingly shadowing the inflationary risks of oil. And the aforementioned spillover effects of Katrina are likely to be distributed over the next few months, especially when the economy has been stretched thin by the factors seen in the chart below.



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