The Hindu Business Line : Markets await Fed move, policy statement

THERE is a deluge of data from the US this week. The Federal Reserve Open Market Committee (FOMC), which meets on June 29-30, will have enough to deliberate on before it makes its much looked-forward to (and all-important) pronouncement on interest rates.

The public noises of the members of the FOMC, including its Chairman, Mr Alan Greenspan, seem to be directed towards reassuring markets that they will not be found wanting if inflation ticks up significantly or rapidly. Hence their talk of the "measured" pace of rate rises in the last post-meeting statement not being an "irrevocable" commitment, if data points to the necessity of aggressive tightening.

At the same time, they have left no doubt that there will not be pre-emptive action on interest rates merely because of the strength of the economy. The provocation to increase rates can come only from hard evidence of rising prices. Clearly, the Fed is distancing itself from the traditional notion of advance strikes to prevent the economy from overheating. This was based on the Phillips curve, which posited a trade-off between inflation and unemployment, i.e., that it was possible to lower unemployment only with tolerance of higher inflation.

The stuffing was knocked out of this theory in the nineties when growth accelerated without putting pressure on prices.

In fact, things got so good (or so bad if you looked at them from the monetarist perspective) that prices fell even as economic activity quickened. Inflationary expectations and bond yields crashed, making the yield curve more or less flat for a considerable period of time till 2001, when the Fed embarked on its rate-cutting spree.

The travails of bonds continued this Monday with the release of good retail sales numbers. Two-year Treasuries are close to 3 per cent - almost double the yields just three months back. The market watches with bated breath for the CPI due in hours of this being written. Later in the week come data on industrial production, capacity utilisation and the consumer sentiment index.

All these put together will deliver a more or less complete picture to the FOMC on the state of the economy and inflation risk. Even if the figures this week are inflation-unfriendly, it does not mean more of the same in the coming months. The Fed may well halt in its tracks after a couple of initial moves. In which case, rates will continue near historic lows for some more time.

What will do the Fed do and say? Nail-biting times are in store for markets till the end of the month.

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