S. Balakrishnan

The game of Fed-watching is assuming frenzied proportions.

Two things make this a particularly nail-biting time for avid players. First, Mr Alan Greenspan exits his Chairmanship on January 31, but not before presiding over another meeting of the US interest rate - setting Federal Open Market Committee (FOMC).

Second, how far from (or close to) is the Fed from the end of the tightening cycle?

On the latter, opinions vary. The latest data suggests that the housing sector, which has been the engine of the US economy for some years, is cooling. Consumer spending has been kept afloat and buoyant because of the property boom.

If this pillar of support is withdrawn, the economy will need adrenalin from business capital expenditure and exports to maintain growth in the range of 3-4 per cent. Corporate balance sheets are in very good shape, so a strong domestic and global economy will be excellent inducement for new investments.

It is, of course, too early to call the finish of the real estate bubble (if one could term it that). After all, a month or two of soft data could well turn out to be blips.

The other worrisome aspect is the recent inversion of the yield curve, i.e., the fall in the 10-year bond yield to below that on two years.

This has generally been interpreted in the past to mean that a recession is on the way.

Again, there are differences about its predictive power in today's vastly changed global economy and financial markets.

Mr Greenspan, for one, doubts it. Many others too in the business of economy-gazing, data-analysis and model-building the US economy don't seem sure.

Two influential voices have thrown their weights behind lower rates down the road in 2006.

Mr Bill Gross, who manages the world's largest bond fund, thinks the Fed will be forced to cut rates in 2006, while Mr George Soros, the billionaire investor, feels the Fed has already gone too far in its tightening. Both forecast a US recession in the near future.

What view will Mr Greenspan and, more important, his successor, Mr Ben Bernanke take? The crucial point is that there is yet no hard evidence that the economy is losing significant momentum.

In fact, QIII GDP was revised upward to more than 4 per cent.

In these circumstances, the odds must be for another 25bps Fed rate rise (to 4.5 per cent) at Mr Greenspan's last meeting.

Beyond that? Bet on Mr Bernanke relying a lot on incoming inflation data and soft-pedalling on rates if core inflation (prices stripped of food and energy) stays in 2 per cent range.

(This article was published in the Business Line print edition dated January 11, 2006)
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