ECRI and the Fed

04Aug06

The research budget here at Abnormal Returns is quite limited. OK, there really is no research budget. We were therefore interested to read a couple of items that highlight some research from well-respected economic forecasting outfit, ECRI. This was especially interesting in light of our hypothesis that increasing economic uncertainty could potentially lead to increasing equity market volatility.

Chart of the Day has a long term graph of the ECRI Leading Index that indicates an economic pause is upon us.

Randall W. Forsyth at Barrons.com has some insight into both ECRI’s future economic and inflation gauges.

… ECRI’s Future Inflation Gauge peaked last October and has been rolling over since. The forecasting group’s leading and coincident measures of employment stopped rising in February and have been losing momentum since. And ECRI’s leading indexes of the U.S. economy are pointing to a clear slowing in growth. [...]

Explains Lakshman Achuthan, ECRI’s managing director, the Future Inflation Gauge attempts to take into account all the factors that influence the change in the rate of increase in the consumer price index. The FIG started moving up in late 2003 and 2004, when everybody was still worried about deflation and long before energy prices took off. But, with the FIG peaking last October, the rate of increase of the CPI should decelerate from here.

At the same time, ECRI’s leading indicators of domestic and global growth are flashing yellow. The long-lead indices—which point to trends a year in advance—have been easing since all the loose monetary policies put in place post-2001 started to be taken back, Achuthan says. Inevitably, those policy lags begin to catch up. Even though he thinks the Fed sees the light at the end of the proverbial tightening tunnel, it’s likely to raise rates once more.

Admittedly these comments were before the most recent employment report. James Picerno at the Capital Spectator notes the simultaneous softening in the labor market while wage pressures continue apace.  Even though the bond market has embraced these weaker numbers with lower yields it is not altogether obvious that the Fed is done with their inflation-fighting campaign.

CNNMoney.com finds a far more certain Bill Gross of PIMCO fame. Gross is quoted as saying, “The Fed will definitely pause on Tuesday,” in addition to publishing a statement that reiterates their willingness to fight inflationary pressures.

Prior to the employment report Barry Ritholtz at the Big Picture noted that a weak number would give the Fed an opportunity to pause. While wages remain an issue the headline numbers may prevail on an already nervous Fed.

The entire reason we should have an interest in what the Fed does is how it affects the real economy and the capital markets. Henny Sender at the Wall Street Journal notes a combination of rising interest rates and more reluctant lenders is making buyout financing more problematic.

Whether we like it or not, monetary policy and economic indicators can and will move the markets. Most investors are unable to profit from the reaction to short-term news, but having a better handle on the intermediate term can be useful.

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