Welcome!

It is a remarkable time to be an observer of the financial markets.

So much has happened to both the United States and Canadian economies over the last 24 to 36 months I wouldn’t know where to begin. So instead of boring any readers with an anecdotal and undeservingly brief history lesson I will concentrate my efforts on what lies ahead. Since we are at the midpoint of the FOMC’s two day policy meeting, I believe it fitting to focus my first post on the state of the US economy. Firstly, how relevant is this meeting? A large portion of Fed observers seem to be of the same opinion that an interest rate hike could be exactly what the economy needs, however, the likelihood of this coming to fruition is extremely remote. This is in fact, in stark contrast to the treasury futures market which is pricing in the likelihood of a series of interest rate hikes, with the first round beginning by the fall meeting. It’s interesting to see how pundits’ policy expectations can change so dramatically when we can all use our short term memory to recall the cold days of winter when it seemed like the Fed was cutting rates on a daily basis and Wall Street was screaming for more. Unfortunately, these rate cuts have done little to ease the credit crunch and have arguably pumped more hot air into an already over inflated commodities bubble.

Commodity inflation, and its flow through effects on production and ultimately consumption, is ‘fueling’ the debate on interest rate increases. It is popular right now to believe that the Fed and the government should coordinate policy to prop up the lowly US dollar, thereby possibly deflating the commodities bubble and in effect helping to spur on a broader economic recovery. This type of action I believe would have a meaningful effect, however, the depreciation of the dollar has been slowly occurring over the last 5 years while the price of crude oil has jumped over 50% since the fed began its interest rate slashing. This tells me that if the dollar is truly the key to bringing down oil prices, the fed has a long way to go before we see levels even close to what we were previously accustomed to.

Unfortunately for the Fed, I believe they have lost what is possibly there strongest policy tool: Credibility. By cutting the target rate several times from 5.25% in September 2007 to the 2% level we are at today and now making the 180 degree turnaround to talk hawkish on inflation is not going to fly with anyone. The signaling effect the Fed has in its statements has the power to affect expectations; open market operations to manipulate the Fed funds rate only has an effect on the short end of the yield curve. By dramatically and systematically cutting rates, then talking tough on inflation when it appears as though they won’t back it up tomorrow, all at a time when the economy is teetering on the brink of recession shows that the Fed has lost touch with the economy. Without having the ability to sway inflationary expectations with signaling subtleties, the Fed is left only with blunt policy tools not fit for use at this stage of the game.

The economy is currently at a very sensitive state, and I believe it is jobs that hold the key to either prosperity or collapse. The media has not labeled this a recession because GDP has not actually turned negative, although those numbers may eventually end up being adjusted; but more importantly in my mind, unemployment is not yet at a point commonly associated with recessionary levels. As inflation moves through the inputs to the end users, producers and manufacturers are finding it increasingly difficult to pass on costs to an already strapped consumer. Herein lies the issue, if costs are passed on across the board, without job cuts, it is theoretically possible to see a wage-price spiral lead to out of control inflation. On the flip side, if labour is cut in an effort to trim costs, no one will be able to buy the very goods being produced (Not to mention the effects on the housing market). According to the Hoover Institution, personal consumption accounts for 70% of GDP, making the employed consumer the key to the economy. This is precisely why I am advocating for a tough stance on inflation to bring down commodity prices from such a blasphemous level and dig out any stifling inflationary expectations this market is creating. This action could lead to job market stability allowing the economy to skirt further deterioration in productivity.