The Hindu Business Line : Fed will stay the course for now

As usual, global financial markets, last Friday, eagerly awaited the release of data on US jobs. The previous week had seen first-quarter GDP growth dipping to just 1.3 per cent (annualised), almost bordering recession.

A weak jobs report would be further evidence of a deteriorating economy and increase the likelihood of the Fed cutting interest rates in the second half of the year.

The forecast was for an increase of 1,00,000 (non-farm) jobs in April, but the actual was less: 88,000. Previous months' figures were revised downward and the unemployment rate rose to 4.5 per cent. In fact, job creation has dropped almost by half from close to an average of 2,00,000 a month to the region of 1,00,000 in the last year.

The market thinks the Fed will slash rates soon. This is reflected in the downward-sloping yield curve, with medium and long-term interest rates being less than the Fed Funds rate and implies that the market is more confident than the Fed that inflation will be under control - in fact, it would be no exaggeration to say that it has more faith in the Fed than the Fed itself.

The so-called `bond vigilantes' - market players punishing Government and the Fed for fiscal irresponsibility and loose monetary policy by driving up bond yields - are nowhere to be seen.

Thus, the Fed's rate increase from 1 per cent to 5.25 per cent has left bond yields (amazingly) untouched.

Despite the sharp tightening of 4.25 per cent, 10-year Treasuries have risen only about 1.5 per cent from their lows of around 3 per cent in 2003.

But monetary policymakers are still on watch. There has been little hint about an interest rate cut. On the contrary, all their talk still focuses on inflation risk.

Not often is there such a wide divergence between Fedspeak and the market's perception of the direction of interest rates.

The latest action on the inflation front suggests that even if the Fed does not move downward, there is little chance of rates going up. Core prices (leaving out food and energy), using the personal consumption expenditure (PCE) index, were up only 2.1 per cent in the last year - a considerable improvement from close to 2.5 per cent earlier. With growth too ebbing, there seems to be no case for aggressive policy.

FOMC meeting

The next meeting of the Federal Open Market Committee (FOMC), the US interest rate setting body, is slated for May 9.

Rates will be on hold. The market will look for shades of changes in the wording of the post-meeting statement. The guess must be that the FOMC will at least mention the economy's subsiding growth, without, however, letting go the inflation bogy.

After all for any central bank, inflation-fighting credentials are paramount.

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