PRINTMarket Update -- Economic Comment
November 5, 2007
The policy statement that accompanied the 25 basis point reduction in the federal funds rate to 4.5% effectively told investors not to expect another reduction anytime soon. The 75 basis points in cumulative action in the last two months was viewed by the FOMC as enough to bring downside risks in economic growth in balance with upside risks to inflation. While this move was initially seen as a rookie mistake by a number of investors, the relatively healthy 166,000 gain in payrolls during October, reported two days later, helped justify the Fed's "no more now" position.
We think the Fed will have a change of heart by the time the December 11 FOMC meeting rolls around. The economy is set to slow precipitously according to our recently revised forecast, and monetary policy works with a lag, so another ease in December will, at best, arrest the pace of decline. It will not stop it. We look for real GDP growth to slow to just 1% in the fourth quarter and remain at a snail's pace for the next couple of quarters. While growth might not meet the technical definition of a recession, it will undoubtedly feel like one. And, there is a significant risk that GDP will indeed recede.
As we said last week: This is the story of the Three Little Pigs, not Goldilocks. While our forecast assumes that the brick house will stand, we think there will be large cracks in the mortar. Come the December 11 FOMC meeting, we expect the Fed will survey the landscape and decide that another 25 basis points in policy easing will not jeopardize the inflation outlook and that a failure to cut could jeopardize the economy. The Fed needs to cut more in order to keep the Big Bad Wolf at bay.
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