The Fed: What the Pros Are Saying

The Federal Reserve finds itself at a critical juncture as Ben Bernanke & Co. approach the June 24-25 Federal Open Market Committee meeting. Despite 300 basis points in rate cuts since last August, the U.S. economy continues to show signs of weakness, and financial markets are still skittish in the wake of the subprime-fueled credit crisis. But policymakers are growing increasingly wary of the threat posed by rising food and energy prices, How will the Fed handle the various challenges at the June meeting? BusinessWeek and S&P MarketScope staff compiled the thoughts of leading Wall Street economists and strategists:

Marc Chandler, Brown Brothers Harriman

What the Fed says will likely be more important than what it does. The statement following the meeting is likely to be about five paragraphs in length and echo some of the recent comments from Fed Chairman Bernanke and other senior Fed officials.

The first paragraph will simply be a summary of the decision to keep rates steady at 2.0%. The second paragraph is the Fed's assessment of the economy. This will likely be similar to the April statement when the Fed said, "…economic activity remains weak." However, given the upward revisions to back-month retail sales data and the fact that, contrary to some surveys, American households appear to be spending a greater part of the tax rebates, the FOMC may tone down a bit its assessment that household spending has been subdued. Following Bernanke's recent comments, the Fed may acknowledge that the risk of a significant contraction of the U.S. economy appears to have eased in recent weeks.

In the third paragraph, the Fed provides its assessment of inflation. Here the wording is likely to stiffen a bit to reflect that commodity prices have continued to rise and that inflation expectations appear to be creeping higher. The FOMC will likely signal not just that it will "continue to monitor inflation developments carefully," as it said in March and April, but will likely indicate that it is on heightened alert or something in that vein.

The fourth paragraph is the Fed risk assessment. It will likely indicate that the ongoing liquidity provisions and past rate cuts can be expected to mitigate the systemic risks to the financial system and the significant downside risks to the real economy. The last sentence of the paragraph will probably be the typically boilerplate promise to do whatever is needed to promote sustainable growth and price stability.

The fifth and last paragraph includes the details of the voting. In April, both FOMC members [Richard W.] Fisher and [Charles I.] Plosser opposed the rate cut, preferring no change in rates. They both dissented at the March meeting, too. A dissent in the face of leaving rates on hold would be a more hawkish development as it would suggest that they wanted to hike rates now.

Jan Hatzius, Goldman Sachs (GS)

Given the current economic data, the federal funds rate is well below the levels implied by standard monetary policy rules. This type of reasoning has led some commentators to argue that while aggressive monetary easing may have been an appropriate response to the "tail risk" of a deep recession in March and April, rates now need to rise because this risk has not materialized. We disagree with this view.

First, monetary policy isn't as easy as it looks as money market spreads are wide, financial conditions excluding the direct effect of short-term interest rates are tighter than last summer, and credit availability has deteriorated sharply. Second, our own outlook for growth and inflation implies that a 2% funds rate will look quite appropriate by 2009, not just from a risk management perspective but also in terms of the central case.