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Daily Forex
Commentary
By Jack Crooks
Key News
The Federal Reserve will raise interest rates at
least three more times this year to keep inflation in check, according to a
majority of Wall Street's biggest bond dealers. (Bloomberg)
Key reports due Thursday (WSJ):
8:30am: May Personal Income. Consensus: +0.3%. Previous: +0.7%.
8:30am: May Personal Spending. Consensus: Unch. Previous: +0.6%.
8:30am: Initial Jobless Claims For June 25 Wk. Consensus: +16K. Previous: -20K.
10am: June Chicago Purchasing Managers Index. Consensus: 54.5. Previous: 54.1.
10am: May Conference Board Help-Wanted Index. Previous: 39.
10am: DJ-BTM Business Barometer For June 11 Wk. Previous: +1.0%.
2:15pm: Federal Open Market Committee announcement.
Quotable
"The measure of success is not whether you have a tough problem to deal with,
but whether it's the same problem you had last year."
- John Foster
Dulles
FX Trading
"It is quite possible that the Fed may decide to push the fed funds rate higher
in order for liquidity growth momentum to start trending down. By doing this
the Fed will set in motion a depressing effect on economic activity some time
in the future - more than likely in 12 months or so time. In the meantime, the
lagged effect of the tighter interest since June 2004 is likely to start to
undermine various activities that sprang up on the back of past loose
liquidity, thereby setting in motion an economic bust," writes Frank Shostak,
adjunct scholar of the Mises Institute.
I think Shostak's straight-forward and lucid description of "why the conundrum"
is a good one. And it explains why a decision on where to stop raising rates is
critical for economic growth and difficult to assess. A couple of interesting
charts from Shostak's piece appearing on the Mises Institute website:
The chart above shows that despite the increase in the fed funds rate, the Fed
was still pumping credit into the economy. Shostak is basically saying here:
conundrum solved!
And here is another interesting chart showing the percentage change in
industrial production vs the fed funds rate. It provides some validation to
Shostak's view of a 12-month lag between changes in the funds rate and when it
starts to show in the real economy.
Shostak's explanation shows us why Fed chairman Alan Greenspan is at least in a
quandary, even if he has figured out the "conundrum". In other words, if fed
fund hikes are starting to bite now, how much more tightening makes sense going
forward? Where is the elusive point of "interest rate normalization"? If the
Fed pulls back on the reins now, does that set off a whole new leg up in the
speculative party layering more froth on top of froth?
It's no wonder Greenspan speaks in such measured phrases. He is smart enough to
understand that no matter where he looks, it seems possible to develop
competing theories to support whatever path he chooses. And given the
complexity of our economy - one based on the irrational action of living
humans, and thus lacking the structure of measurable supply and demand curves
that appear in our textbooks - Mr G's tools for evaluation of the impact on the
economy from monetary policy past is also quite limited.
Where is this so-called equilibrium in the economy? In a dynamic economy, with
fluctuating prices, there is no such thing. There is a tendency toward
equilibrium - or subjective evaluations of that point, but no such thing is
achieved - otherwise prices would stop fluctuating. And an economy without a
price system is an economy that is dead. The Soviets tried to override
fluctuating prices.
Is there a point here? Well maybe. The point I am trying to make is: first, we
can't forecast interest rates because the people in charge of manufacturing
interest rates can't do it either; and second, we need to focus not on the
theory, which can help us understand in retrospect, but on expectations.
"If the process of adjustment does not lead to equilibrium, what happens to the
conclusions of economic theory? The answer is that they remain valid as
deductions but they lose their relevance to the real world. If we want to
understand the real world, we must divert our gaze from a hypothetical final
outcome and concentrate our attention on the process of change that we can
observe all around us," write George Soros.
So, we may be able to guess the final outcome Thursday from the Fed. But the
key will be guessing the real world reaction as reality plays out against
consensus expectations. Now that's a conundrum that will be with us for a long
time to come.
Jack Crooks has actively traded in global equity,
fixed income, commodity, and currency markets for more than 20 years. He is
president of Black Swan Capital, a currency and commodities market advisory
firm - BlackSwanTrading.com
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