Too Much Time Left on the Clock

As we await today's monetary policy decision from the Federal Reserve, we ponder the motivation behind what board members say and do ...

Do Federal Reserve Board members really not know what is going on in the world today or are they just unable to say what's really on their minds in fear of spooking the markets and starting a panic?

Is Alan Greenspan like the elder George Bush in the 1992 checkout scanner incident (so far removed from the lives of ordinary people that he was unfamiliar with grocery store checkout scanners), or is he all too aware of the impact his words have on public confidence, and therefore chooses to measure these words carefully?

Probably somewhere between the two extremes.

Closer to one extreme than the other? Probably.

Which extreme? Who knows?

One thing is a good bet though - Mr. Greenspan is not stupid. He knows that the U.S. and the rest of the global economy are in uncharted territory - he must have read something that Paul Volcker, Warren Buffet, Bill Gross, or Stephen Roach have written over the last few years.

He must realize that at this point in the game, small shocks could have big consequences. With retirement looming, the less change that is forced upon the U.S. and the world's economies, the better.

At this point in the game, if he really had a choice, surely he would prefer to just "run out the clock". That is, to continue raising rates in quarter point increments with no changes to the policy statement until his term expires in January. This seems to have worked well for the last year - nothing has imploded, no major mishaps.

Unfortunately, it appears there is just "too much time left on the clock".

Meetings in June, August, September, October, and December with no change to policy or language would take the Fed Funds rate from the current 3.0% to 4.25% with an expected rise to 4.5% at the end of January, just as the retirement festivities are in full swing.

Historically, short term rates such as these would not be cause for alarm - in fact 4.5% is a full point below the average Fed Funds rate of the last fifty years. From a historical perspective there should be nothing wrong with raising rates to these levels. But, could the economy handle short rates like these?

What would happen to stocks, bonds, commodities, hedge funds, and the real estate market if short-term rates rose to these levels? What would happen if rates stop rising?

We'll find out soon enough.

Today, everyone expects the Federal Reserve to raise the Fed Funds rate from 3.00% to 3.25% - the only uncertainties are whether the wording of the policy statement will change or if there will be another mix-up like last month when a sentence about long-term inflation expectations was misplaced.

It is unlikely that there will be any substantive changes to the policy statement or that there will be any mix-ups this month, but sometime between now and next January something is bound to change.