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FOMC Admits Inflation Uncertainty, Cuts Anyway

by: The Prudent Investor posted on: May 01, 2008 | about stocks: DBC / DIA / DJP / FXE / GLD / IEF / IVV / SPY / UDN / UUP

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The Federal Open Market Committee's [FOMC] widely expected move to cut the Fed Funds rate by 25 basis points to 2% fails to instill confidence. Citing both the sagging economy and a highly uncertain inflation outlook, the FOMC favored in an 8-2 split vote to try and stimulate the economy with cheaper credit.

This will not go down well with consumers and businesses suffering from a parabolic rise of their daily expenses. CNBC had an interview with the president of the American Retail Bakers, whose name I did not jot down. The lady was not too happy about the Fed's move. She would have preferred to see a sign that the Fed is truly concerned about inflation and will do something against it. Wall Street was disappointed too. In a classic "buy the rumor, sell the news" move, it erased its gains made earlier in the day and ended down.

The FOMC statement was hardly changed:

Recent information indicates that economic activity remains weak.

This may indicate that the FOMC assumes that the economic downturn will soon begin to flatten out. In March the FOMC had stated "that the outlook for economic activity has weakened further."

Household and business spending has been subdued and labor markets have softened further.

The credit crunch that obviously has not yet abated, despite the orgy of irresponsible rate cuts since last August, seems to have spread in the perception of the FOMC. In March they only mentioned slower growth in consumer spending.

Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.

No changes here. The outlook remains terrible. At least the Fed has more polished words for a drawn out slump.

Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months.

In order to come up with at least one improvement the FOMC points to the unpopular core inflation rate. This ain't gonna help at the gas pump or the supermarket. Regarding the second part, I am immediately reminded that Alan Greenspan, towards the end of his tenure as Fed chairman, said that gold is an excellent inflation indicator. Gold closed higher after the release of the statement. The first, albeit weak correction in gold's downtrend may be seen as a sign that gold is currently heavily oversold.

The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.

A comparison with the March statement evokes the thought that even the Fed has arrived at the opinion that inflation will remain a problem.

There must have been an intense discussion of accelerating consumer prices. Fed presidents Richard Fisher (Dallas) and Charles Plosser (Philadelphia) had

preferred no change in the target for the federal funds rate at this meeting.

Re-reading the dovish FOMC statement I again conclude that Federal Reserve Notes [FRN] will soon continue their fundamentally driven descent. As written a month earlier, there are no signs that the Fed will veer from its textbook course of inciting hyper-inflation in order to satisfy the financial sector's unrelenting demand for more cheap money.

As the Fed has not changed its questionable strategy, I see no reason to change mine and stay thus remain long commodities and precious metals. The current correction will remain merely a correction in the long-term uptrend. We are a long way from the end of this inflation cycle, which may have already escaped the boundaries of central bank policy.

FRN's could take their next hit next week. Increasingly hawkish tones from Eurozone central bankers open the possibility that the European Central Bank [ECB] may strengthen its words on May 8 and prepare markets for some action in the summer. Central banks around the world have tightened rates for a while now. Only Japan, the Eurozone, the UK and the USA have missed the train of monetary responsibility, instead preferring to feed an ailing banking sector that went berserk in the absence of effective regulation.

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