Sunday, October 28, 2007

Counting Votes: What Will The Fed Do?

What's the Fed going to do on October 31st? To get an idea, I've gone back over everything they've said since the last meeting to try and figure out how each FOMC member is likely to vote. Below I've listed the three options the FOMC is likely to consider, along with arguments for each outcome, all culled from recent Fed speeches:

No Change:
We have yet to see convincing evidence that the housing recession is spilling over into the broader economy. While mortgage-related credit markets continue to be tight, prime corporate borrowers have seen little net change in their borrowing costs and their access to credit remains largely unaffected; labor markets remain tight, especially for skilled labor, and real income continues to grow at a healthy pace; exports have been strong due to a strong global economy, and inflation remains a risk partly due to higher oil prices and a weak dollar.

25 Basis Point Cut:
Residential investment has weakened more than expected, and inventories of unsold homes continue to grow. Home prices are falling in many areas of the country. Growth in consumer spending shows signs of slowing; higher credit costs for non-prime borrowers and reduced availability of credit have the potential to further weaken consumer spending growth; Uncertainty remains high and risks remain skewed to the downside. Additionally, core inflation has continued to trend down, implying the stance of policy has grown slightly more restrictive.

50 Basis Point Cut:
Given the large and growing inventory of unsold homes, further home price declines are likely. With mortgage-related credit markets remaining dysfunctional, a precipitous decline in housing prices cannot be ruled out. Should this occur in the face of a possible decline in employment, the downside risks would be significant, since job losses would further weaken demand for housing creating additional negative feedback effects. Given the long lags between policy actions and their impact on the economy, and the possibility that economic downturns can be difficult to reverse once they take hold, additional preemptive rate cuts are needed to insure against this outcome.

Counting Votes
With those set of options, let's turn to the members of the FOMC, whom I've listed below, plus the participants without votes. Links are to all the tagged posts here. Next to each name I've listed my best guess, if I have one, for what option or range they'd accept, along with their main concerns based on their public statements since the last FOMC meeting.

Board of Governors
Ben Bernanke: 25 bps, Insurance against downside risks; Taylor adjustment
Donald Kohn: 25 bps, Downside Risks.
Randall Kroszner: ?
Frederic Mishkin: 50 bps; Financial instability; Insurance against downside risks.
Kevin Warsh: ?

Regional Fed Presidents with votes:
Timothy Geithner, New York: ?
Eric Rosengren, Boston: 25 bps, Insurance against downside risks.
Charles Evans, Chicago: 25 bps, Insurance against downside risks.
Thomas Hoenig, Kansas City: 0-25bps
William Poole, St. Louis: 25 bps, Potential for housing spillover; Downside risks.

Regional Fed Presidents without votes:
Sandra Pianalto, Cleveland*: ?
Charles Plosser, Philadelphia*: 0-25 bps; No housing spillover; Taylor adjustment.
Richard Fisher, Dallas*: 0-25 bps; No housing spillover; Inflation risks remain.
Gary Stern, Minneapolis*: ?
Jeffrey Lacker, Richmond: ?
Dennis Lockhart, Atlanta: ?
Janet Yellen, San Francisco: 50 bps; Financial instability; Insurance against downside risks; Taylor adjustment

*voter in 2008

That leaves quite a dispersion of opinion. So how might this play out? The inflation hawks (Hoenig, Lacker, Plosser, Poole) might argue for no rate cut, but with core PCE falling, expected to continue falling, and well inside the Fed's comfort zone, those arguments won't get very far. Plus only two of the hawks have votes. Mishkin and Yellen will likely make the case for a 50bp cut, but without more evidence of weakness outside of housing, that will be a tough sell, unless Fed staff has significantly downgraded its Greenbook economic forecast. That leaves a 25bp cut as the easy compromise outcome, which is my prediction.

The Fed Funds options market is also expecting a 25bp cut;
Karl Smith at Modeled Behavior expects the Fed to stand pat;
Tim Duy at Economists' View also expects no cut, but is worried;
William Polley expects a 25bp cut, but hopes to see a few hawks dissent;
knzn also expects 25bps, but thinks they should cut more;
Greg Ip, at the WSJ Blog, provides his summary of possible outcomes.

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