Uh yeah, I'll take a quarter point cut with a side of dove and a diet misleading GDP
I enjoyed predicting what the Fed was going to do last meeting so much (see article: Step right up, place your bet...), that I've decided to do it again. Like most people, I am looking for the Federal Reserve to cut rates by a quarter point in a couple of hours. The key here is what its accompanying statement will be like. In my opinion they should issue a dovish statement, or at least a truly neutral statement, which would be interpreted as being dovish anyhow.
I'm sure you're saying to yourself, "This guy is nuts. Inflation is out of control. The Fed needs to stop already. They better issue a hawkish statement." Sure, the falling dollar has exacerbated the inflation problem somewhat, causing oil and grains to rise more quickly than they probably would have. But you know what, their prices were going to increase dramatically anyhow regardless of what the Fed did with rates. Underneath all of the talk about a weak dollar, this is a demand driven bull market for commodities created by rising demand from emerging markets for a finite amount of oil and grains.
What the weak dollar that the Fed has created by lowering rates has done is actually mask the underlying weakness in the U.S. economy. When the government published the first quarter GDP this morning, the headline number was a rise of 0.6%, which was in line to slightly above analysts estimates. Not to bad right? Wrong? The GDP was actually much worse than this when one backs out the increased demand for U.S. goods that the weak dollar has created. U.S. exports increased by 5.5% during the quarter. If one backs out the gains in exports and a build in the inventory of goods that businesses have produced but not yet sold, the GDP during the first quarter actually was -0.4%. This is would be the first drop since the end of 1991.
Back to why I want a dovish or at least a neutral statement. The only thing that the Fed will accomplish by making a hawkish statement is make itself look foolish with a small "f" when it has to once again change its mind and cut rates again later on this year or in early 2009 (if the stimulus package delays the inevitable). The U.S. economy is in much worse shape than the headline GDP number indicates. A hawkish statement by the Fed today would likely cause a short-term spike in the U.S. dollar. A significantly higher dollar for a period of several months would probably hurt U.S. exports, which is one of the only things that it masking the true ugliness of the current state of the economy. Once exports slowed down, the GDP would fall off of a cliff and the Fed would have to cut rates anyhow, making itself look stupid in the process for stating that it wasn't going to.
There's nothing wrong with slowing down the breakneck speed at which the Fed has been lowering interest rates, but to completely rule out future cuts would be a huge mistake.