Fed Funds at 4%? Not Until Year-End 2005??????

Seems Bloomberg is a bit behind the curve since at 1.235 percent, the yield on the July federal funds futures contract indicates about a 95 percent chance the Fed will lift its target by a quarter percentage point at the June 30 meeting!

:-)

http://quote.bloomberg.com/apps/news?pid=nifea&&sid=an8F.bp6EYqE

Fed Funds at 4%? Not Until Year-End 2005, Survey Says

May 21 (Bloomberg) -- <snip>The Fed's current target is more in line with an economy in recession than one that has expanded at least 4 percent in the last three quarters and had an annualized inflation rate of 4.4 percent through April, according to economists such as Deutsche Bank AG's Cary Leahey. The Fed lowered the rate to 1 percent in June, when it was concerned about deflation, or a generalized decline in prices.

"The rate they have right now is an emergency rate -- they want a rate that is more consistent with the economy's growth (at least 4 percent seems the "neutral,"neither stimulative nor restrictive rate)," said Leahey, 51, a senior economist at Deutsche Bank's U.S. securities unit in New York. <snip>

The difference in yield between the benchmark 10-year note, a 4 3/4 percent coupon due May 2014, and the 10-year Treasury Inflation-Protected Security has widened to 2.72 percentage points from the low this year of 2.15 percentage points on Jan. 15. The widening spread is a sign investors expect faster inflation. The gap averaged 1.89 percentage points in the past five years, and the current spread is the widest since the Fed started selling TIPS in 1997. <snip>

"The Fed will have to get moving fairly soon because inflation has bottomed and is now starting to rise," said Gary Bigg, 50, an economist at Banc of America Securities in New York. "The Fed wants to quell that." The yield on the 10-year note will reach 5.6 percent by the end of 2005, he said.

Deflation is where you need less money to buy things right? So why is it such a bad thing?

It isn't just that you spend less money for things today than yesterday. It's that you know they are going to cost even LESS tomorrow. And even less the day after that.

Would you buy a new car today for $20,000 that you knew would be $19,500 tomorrow? And cheaper after that? Nope - you would put off all expenatures possible for as LONG as possible. Right?

That can cause massive economic slowdowns, and business would keep lowering prices to try to sell their inventory. Profits would plummit and (where they weren't laying people off in droves) salaries would fall ("we can't afford to pay your salary, and since the cost of the things you buy is going down...").

MASSIVE problems. It's taken Japan about a decade to slowly get themselves out of the deflation mess even with massive stimulation (0% rates).

So, yeah, you "need less money to buy things", but you HAVE less money... LOTS less money. The one thing that wouldn't cost less? Your debt payments that would be getting harder and harder to pay on your shrinking salary. And with your house becomming less valuable, lots of people would decide to just go bankrupt.



Deflation in FAR more dangerous than inflation.

That was a consise, clear explanation. Thanks for posting.

I see how it works now. :)

The problem with deflation goes deeper than just prices of things.

THe biggest problem with deflation is that it makes repaying debt more difficult.

The dirty little secret of modern 'capitalism' is that it is based upon an ever increasing amount of debt and that in turn is based upon the NECESSITY for inflation. You see inflation means that each dollar is really worth less. So when you borrow today and pay back tomorrow you are paying back cheaper dollars. The system DEPENDS upon this. As the famous SNL sketch had Carter saying, "Inflation is our frined"

The depression was our only period of deflation in the last century. Prices of THINGS dropped but that wasn't the killer. What was the killer was the default of so much debt, which meant bankruptsy for so many bussinesses and individuals.

Obviously this put the banking system at risk. Obvioiusly it put the entire financial system, especially stocks and all capital markets into disarray as well. The DEFLATION of stocks and asset prices was the real nut of the depression. Yes, the prices of things from cars to toasters dropped a bit but the 12 year long malaise was highlighted by seize up of the credit system as worthy borrowers were hard to find and those willing to borrow was even smaller. Most people didn't recognize it at the time but the unwillingness to borrow was rooted in the understood in the gut but not understood by the mind idea that if you borrowed you would have to pay back with more valuable dollars.

You see we think of inflation as higher prices but think of it as less valuable money. With inflation money becomes more plentyfull and thus 'cheap'. With deflation money becomes more scarce and more 'valuable'. In the depression cash was king.

Think of inflation as the grease which keeps the system, especially the credit system working smoothly.

I have to add that few, here especially, appreciate that what we see in the totality of economic activity broadly defined as 'capitalism', is ABSOLUTELY dependent upon credit Well credit and it's obverse side, debt. WIthout an ever growing supply of credit the system contracts. Bussiness and economic cycles are NOTHING MORE than credit cycles.

Deflation is the death of debt and the death of economics as we know it in the modern world. Deflation is unacceptable. EVERYTHING will be done and is being done to prevent it. Now a bit of deflation in the price of things, which we have seen in all that stuff we buy at Chinamart is one thing but the the real risk is that the price of stocks all the other kinds of financial assets, most of which are based upon debt, and residential real estate might fall. While stocks did fall, and today May 21, is the 3rd anniversary of the all time DJIA high, the prices of many other financial assets and more importantly homes didn't fall. THe system had some trouble but survived. To save the system Greenspan and his partners, the global financial system, led us on a stupendous credit/borrowing binge.

Making the risk of deflation in those asset prices many times greater.

What's so bad about deflation. Look at those old pictures of Depression bread lines and imagine the Army in the street disperseing those freinds of the terrorists asking for handouts, from a broke government.