Fed Pauses, Markets Stumble

Posted Aug 8th 2006 2:45PM by Peter Cohan

The Fed just announced that it would pause in its rate raising -- big mistake! Bernanke is in danger of abandoning the core mission of the Fed -- to keep inflationary expectations in check. And the market fell after being up prior to the announcement.

The Fed should have raised rates 25 basis points this afternoon. But it didn't. The Fed decided that its need to control inflation was less important than its desire to keep the economy out of a recession. As I noted in a post yesterday, the Fed does not view consumer price inflation as the relevant measure -- instead it focuses on labor cost increases which are way above target.

Specifically, the reason the Fed should have raised rates is that inflation exceeds the 1% to 2% target that Bernanke set. This morning's productivity report showed that unit labor costs rose 4.2% in the spring – this is way above the 3.5% growth expected by economists that Reuters surveyed.

In the wake of this report, the interest rate futures market still assigned a 79% chance that the Fed would not raise rates this afternoon. And the interest rate futures market was right.

This tells me that the market was wagering that the Fed believed that a recession which will crush wage inflation is already baked into the cards.

The only questions now are how long it will take for that recession to unfurl and whether that recession will temper the roaring consumer price and wage inflation which today's productivity report revealed.

Peter Cohan is President of Peter S. Cohan & Associates, a management consulting and venture capital firm, and a Professor of Management at Babson College.

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Reader Comments (Page 1 of 1)

8-08-2006 @ 3:56PM

Robert L Carlson said...

Workers pay is up and that is good because of the little bit of energy price push we have seen trickle down, workers have increased their productivity and deserve the increased pay after years of hard work in the global economy !!!!

8-08-2006 @ 5:55PM

Jerry Bluhm said...

The last time the Fed Chairman meet in front of the Senate I felt he was a little intiminated by what he was told by one of the Senators so he caved in and did not raise rates. He should have raised rates if only to let us all know who is in charge of regulating rates, the Federal Reserve or Senators. I am afraid Mr. B lost face again.