Macro Man, for one, has tried to separate macroeconomic policy drivers from microeconomic drivers. The microeconomic case for policy relief is fairly strong, as a market fairly central to the entire financial system (and by extension the economy) has more or less ceased to operate. Providing term liquidity is not about bailing out rich bankers or hedge fund managers; rather, it's about helping to ensure that Main Street banks are not so risk averse that they refuse to lend to high quality household and business borrowers. That's why he thought that doing 0.25% on the discount rate was an own goal.
And what of the macroeconomic case for policy easing? As far as Macro Man can make out, the entire case can be summarized in the chart below.
Housing has taken a dent out of growth mechanistically via reduced housing investment from homebuilders. And yes, as the chart above indicates, there has been a hit to household wealth, and thus to consumption. But housing equity doesn't tell the whole story, of course. Aggregate household wealth is still comfortably positive on a y/y basis.
Now it's true that housing wealth is spread more democratically than aggregate household wealth. But the studies that Macro Man has seen can divine no real difference in the macroeconomic consumption function from housing as opposed to equity wealth. At the end of the day, aggregate wealth is what matters....insofar as wealth matters at all. Income remains the primary driver of spending, and despite recent revisions US income growth remains supportive.
And so we're left with the chart below, which isn't the sort of thing that you'd expect to see accompnaying a 100 bps easing cycle, with plenty more baked into the cake as well!
Nor is the chart below. Yesterday's PPI data notched a couple of milestones: the highest monthly rise in finished goods prices since 1973, and the highest y/y rise in 25 years. Today sees the release of CPI which, if it prints 4% or above on headline, will win Macro Man a crisp £20 note from a colleague.
Given the relatively complacent Fed inflation forecast for 2008 and beyond, it's really worth considering how much more inflation the Fed will be prepared to tolerate, particularly in the absence of contagion. Now that the world's central banks have at least started to get their finger out in developing microeconomic solutions to the money market problem, perhaps it is time to start contemplating what the macroeconomic consequences might be.
For a start, one would have to think that an easing in January is less than a 100% chance, which is what's currently priced into markets. Of course, the environment could deteriorate on the data front, but Macro Man is mindful that last January saw the release of a skein of stronger-than-expected US data.
By the same token, further reductions in Fed funds with the Main Street economy doing OK will simply stoke further inflation pressures and probably generate a rise in the US import bill. Neither would be particularly supportive for the dollar.
For the time being, of course, anything remains possible due to the uncertainty surrounding the money market. No one ever said that the Fed and other central banks have an easy job....but then again, neither do those of us charged with making profitable trades on the back of what those guys decide to do. As long as market confidence remains this fragile, smaller-than-usual positions make sense. In many ways, Macro Man was relieved to see a signal to take off his FX carry basket this morning; FX carry is no place to be when liquidity is lousy, interest rates are rising, and there's a potentially high CPI print in the pipeline.