Hawks will not prevent more Fed rate cuts

Washington: Federal Reserve hawks will not prevent more interest rate cuts designed to bolster the US economy, but they may temper the depth of future policy easing and help keep inflation expectations contained.

Two dissenting votes on Tuesday against the Fed's cut of three-quarters of a percentage point in the overnight interbank federal funds rate to 2.25 per cent marked the first time since September 2002 that a pair of policymakers defied their Fed colleagues.

"This is positive. It shows people that this is not just a rubber-stamp Fed that follows the chairman," said former Cleveland Federal Reserve Bank President Lee Hoskins.

"Dissents are important, both inside the Fed and as a signal to markets," said Hoskins, arguing it was crucial that the Fed not water down its goal for price stability as it fought financial market stress sparked by the subprime crisis.

The hold-outs against the 75 basis point cut by voting members of the Federal Open Market Committee were Dallas Fed President Richard Fisher and Philadelphia Fed chief Charles Plosser. Both argued for less aggressive policy action.

Plosser is an academic economist of international standing and Fisher a successful hedge fund manager and former US trade representative. Both recently voiced concern about rising inflation, and Fisher had dissented against the Fed's last rate reduction on January 30 as well.

Inflation credibility

"It seems as if the [FOMC] wanted to regain some inflation credibility after focusing on the financial sector and the economy of late," said Harm Bandholz at UniCredit Markets and Investment Banking.

In addition, only three of the 12 regional Fed branches were immediately on board with the accompanying three-quarter point cut in the discount rate charged on direct central bank loans to financial firms, although five others quickly joined the ranks.

"The nature of the decision - featuring two dissents and only three banks asking for a parallel cut in the discount rate - sends a hawkish message to the markets," said Goldman Sachs economists in a note to clients.

Goldman Sachs said more rate cuts probably lay ahead, but that opposition likely was stiff to the full percentage point cut that interest-rates futures showed that markets had expected.

The Fed did sharpen its language on inflation and pointed out some measures of inflation expectation had risen, in a nod to the recent widening in the spread between US Treasury notes and Treasury inflation-protected securities.

The dissenters probably had this deterioration in mind when they took the decision to oppose their colleagues in the midst of a financial market crisis that has already prompted unprecedented emergency action by the US central bank.

"Fisher and Plosser are just trying to temper the Fed's aggressiveness," said Gregory Hess, a professor of economics at Claremont McKenna College in Claremont, California.

Trigger

They want "to remind people that there is a trigger at which the Fed will think that the inflation expectations have gotten beyond what the Fed can tolerate," Hess said.

The 10-year TIPS spread has drifted up from around 2.35 percentage points to 2.70 percentage points in recent weeks, although it has narrowed somewhat in recent days.

It edged up by around 10 basis points again on Tuesday as underlying Treasury prices sagged amid a rampant stock market.

"The Fed is obviously in a position where there are no good choices and one of those bad outcomes is if inflation expectations rise. I think that the fact that people know that there are some [policy-makers] reminding people that there is an issue can only help to contain them," said Hess.