The Federal Reserve interest rate decision is fast approaching, and traders are at a loss as to what the central bank will do next. Fed Chairman Ben Bernanke said in a speech last week that the main question confronting policy makers at its next meeting is whether growth is fast enough to make "material progress" in reducing the unemployment rate. This essentially implies that the growth forecast is key in determining the Fed's next step.
Bernanke's statement divided the market right down in the middle. On the one hand, there are some who believe that the Fed will implement action due to the disappointing economic data we've been recently seeing. But on the other hand, there are also analysts who think that the bad data isn't sufficient to force the Fed's hand.
Aye for Action
When I say "action," it doesn't necessarily imply quantitative easing. The Fed can do a variety of things to ease--from outright asset purchases to communicating an easing bias with an "activation clause" to just simply continuing Operation Twist. Any, or a combination of these, is really possible.
One of the main arguments for action is the glum economic forecast. The U.S. economy isn't closing the employment gap as quickly as initially predicted by the Fed, which is putting a lot of pressure on them to do more. The frailty of the U.S. economy could be clearly seen by how weak the jobs data and the retail sales report came in.
In fact, even top financial institutions have downgraded their growth forecasts for the second quarter of this year. Goldman Sachs reduced their projection to 1.6% from 1.8% while Credit Suisse Group AG cut their forecast to 2.2% from 2.5%.
There are also a few members of the FOMC that share this sentiment. Vice Chairman Janet Yellen of the Federal Reserve, who given her position is undoubtedly a strong voice in the FOMC, said that there's scope for further easing at some point to prevent the jobless rate from staying above 8%.
Meanwhile, "lesser" members of the FOMC like San Francisco Federal Reserve President John Williams believes that real GDP will only expand at a moderate pace of about 2.25% this year and around 2.5% next year. He thinks that the unemployment rate will remain at or a bit above 8% for the remainder of this year.
Nay for Action
Of course, there are those who disagree that the Fed will implement any action. On the disappointing jobs data, analysts point to a speech done by Bernanke recently. He indicated that the apparent slowing of the labor market is greatly exaggerated due to the unusually warm weather and seasonal adjustments. Bernanke seems to suggest that this weakness we're seeing is merely a bump in the road, and not indicative of the long-term trend.
The report from the twelve Federal Reserve Districts, more popularly known as the "Beige Book," suggests that the situation isn't as bad as it seems.
According to the latest Beige Book, economic activity actually expanded at a moderate pace from early April to late May, and that manufacturing continued to show strength in most districts.
Consumer spending didn't decline while the sales of big ticket items like new and used automobiles held steady. Basically, anecdotal stories were vastly different from what economic data have been saying.
Now, while it is true that we cannot accurately predict what the Fed will do, we can always look at the facts available to us and make our own educated guesses. And no matter the conclusion you make, always remember that nothing is certain and to always limit your risk!
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