The Fed minutes touched off a bear flattener, which tells me the market is decreasing the overall degree of easing and/or the time period the Fed will leave rates at the cycle low. This is emphasized by the 2-year, which sits at 4.14% after having fallen as low as 3.83% on 9/10. The current rate on the 2-year is only 60bps below the current target rate, suggesting that the total amount of Fed easing will probably only be another 75bps or so.
The minutes themselves had a little something for every one. There was upbeat news on the economy overall, but housing was viewed as a strong drag. I think the portions the market was focused on where statements like this:
With credit markets expected to largely recover over coming quarters, growth of real GDP was projected to firm in 2009 to a pace a bit above the rate of growth of its potential. Incoming data on consumer price inflation that were slightly to the low side of the previous forecast, in combination with the easing of pressures on resource utilization in the current forecast, led the staff to trim slightly its forecast for core PCE inflation. Headline PCE inflation, which was boosted by sizable increases in energy and food prices earlier in the year, was expected to slow in 2008 and 2009.
My take away is as follows:
- The Fed isn't going to keep cutting just because we have a credit crunch. They seem to view that problem as short-term.
- GDP growth is likely to be pretty slow in 2008, but accelerate in 2009. If that forecast remains in tact, the Fed isn't like to cut aggressively in 2008, less the 2009 bounce create inflation pressure.
- It sounds like they think food and energy prices will moderate just based on mean reversion. I didn't see any stronger justification for this view. I think the Fed wants this to be the case, since higher food and energy prices are threatening to solidify consumer expectations for higher inflation rates in the future. So their statements on moderating food and energy prices may be more purposeful talk than analysis.
- I think their view on housing continues to get worse. However, if you read between the lines here, I think there are people on the committee who don't want to cut rates so long as housing is an isolated area of economic weakness. I think the reasons for ignoring isolated weakness in housing is akin to reasons why they're ignoring isolated rising prices in food and energy.
My bearish view on intermediate term rates remains in tact. I still think the 10-year is rich at 4.65%. The 2-year is close to fair value if not slightly cheap.