Looking for dissent at the Fed

By Paul R. La Monica, editor at large

NEW YORK (CNNMoney.com) -- It's going to be a phenomenally busy week in Washington.

The Senate is trying to hammer out a compromise on a Wall Street reform bill and Goldman Sachs executives take center stage at a Senate hearing Tuesday to respond to questions about the SEC's fraud accusations.


So it would be easy to forget that there's another big news event coming from the nation's capital: the Federal Reserve's interest-rate setting committee wraps up a two-day meeting on Wednesday.

Sure, the Fed announcement may appear to lack the drama of the Senate debate and the appearance of the "fabulous" Fabrice Tourre, the Goldman employee at the heart of the SEC probe.

Everybody knows that the Fed is going to once again keep interest rates near zero, which is where they have been since December 2008, and reiterate that rates will remain "exceptionally low ... for an extended period."

"The Fed statement is going to be more or less a carbon copy of the March statement. They don't want the market to misinterpret anything," said John Derrick, director of research for U.S. Global Investors, a San Antonio-based money manager. "I don't think they want to make a move yet since they still question how sustainable the recovery is."

But while it's tempting to dismiss the Fed announcement as the equivalent of simply following the directions on a shampoo battle (lather, rinse, repeat) that would be a mistake. There is some intrigue surrounding the Fed's latest statement about the economy.

Investors will be focused on two key things: how bullish the Fed sounds when discussing the recovery and whether more Fed members dissent with the Fed's decision to keep saying rates will stay "exceptionally low."

In the Fed's last statement in March, central bankers did note that the economy "continued to strengthen" and the job market was "stabilizing."

Still, that was hardly a glowing assessment of economic conditions. The Fed added that housing starts were "flat at a depressed level" and that companies "remain reluctant" to hire more workers. With that in mind, the Fed noted that it expected the pace of the recovery to be "moderate for a time."

So until the Fed is willing to say that the economy really does appear to be picking up a head of steam, it's unlikely that any rate hikes are in the cards just yet. And economists said little has changed since March to suggest that the Fed now has a far more rosy view of the recovery.

"The Fed is notching up its outlook for the economy inch by inch," said Kurt Karl, chief U.S. economist with Swiss Re in New York. "There's no inflation at this time so the Fed might be a little more optimistic. But the 'extended period' language about rates is likely to stay until later this year."

Stuart Hoffman, chief economist of PNC Financial Services in Pittsburgh, agreed. He said the Fed will probably remain cautious and will offer up another muted outlook.

"Their view of the economy might be a little more positive but we're waiting for them to talk about the recovery being self-sustaining. The Fed may still be viewing the economy in shades of gray," he said.

Nonetheless, there is a growing chorus of critics who think the Fed is sowing the seeds for another asset bubble or runaway inflation by leaving rates near zero for this long. It appears that this group even includes a member of the Fed's policy-setting committee.

Kansas City Federal Reserve president Thomas Hoenig, a so-called inflation hawk, has voted against the Fed keeping in the "extended period" language at the last two meetings.

In the March statement, the Fed said Hoenig was worried that the Fed risked "the buildup of financial imbalances" by perpetuating the notion that rates would stay "exceptionally low."

Hoffman said that it will be interesting to see whether Hoenig remains the lone dissent or if he is able to recruit any other Fed members to his camp of hawks. (Yes, I've been watching too much "Lost" but I do not mean to imply Hoenig is the Man in Black to Ben Bernanke's Jacob. Or should it be the other way around?)

"I wouldn't rule out someone else dissenting," Hoffman said. "If there were another dissent, that would be meaningful since it might mean there's more concern about leaving interest rates this low for this long."

Derrick said he wasn't sure if anyone else would join Hoenig in voting against the decision to keep the "exceptionally low/extended period" language. But he agreed that the Fed may soon face more calls to change the statement in order to prepare the markets for an eventual rate hike.

"It seems like the economy is stronger than the Fed wants to acknowledge so there may be more pressure to raise rates. There could be a rate hike as soon as September," he said.

But Karl said that any talk of a rate increase is way too premature. He argues that as long as the unemployment rate remains as high as it is, the Fed's going to stand pat.

After all, the Fed has shown an unwillingness in the past to raise rates in fits and starts. The thing about interest rate hikes, much like Lay's potato chips, is that you can't just have one.

"Once the Fed does get moving they probably will move rapidly," Karl said. "So they're not likely to start raising rates until the first quarter of 2011. We need a year of strong employment growth before the Fed should consider hiking interest rates."

- The opinions expressed in this commentary are solely those of Paul R. La Monica.  To top of page

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