This morning's Wall Street Journal includes an article taking note of the recent hawkish tone emanating from the Federal Reserve:
The Fed's inflation hawks are sharpening their talons.
High energy prices, a potential shift in public psychology toward accepting higher prices, signs thbat businesses are using up spare capacity and a steep federal budget deficit combine to make Federal Reserve policy makers more nervous about the inflation outlook. A pause in rate increases the next few months, considered a real possibility after the economic disruption caused by Hurricane Katrina in late August, looks increasingly unlikely. Indeed, the Fed may raise rates even further than it had thought likely before Hurricane Katrina struck.
The article includes -- WARNING: Shameless self-promotion ahead! -- the Michigan inflation expectations graph macroblog highlighted some weeks ago, as well as an up-to-date picture of the implied funds rate based on December futures contracts. The latter highlights the Katrina-driven plunge in the expected funds rate path, followed by the subsequent reversal to levels that now exceed pre-hurricane expectations.
A closer look at last week's Carlson-Craig-Mellick estimates of expectations derived from options on federal funds futures reveals something interesting, however. To be sure, 4 percent after the November 1 meeting of the Federal Open Market Committee still looks like a lock...
... and another 25 basis points is the clear front-runner for the December meeting:
But note that the probability assigned to that outcome slid a bit over the week, despite the tough talk coming from FOMC participants. The news of a computational error that caused an overstatement in the Commerce Departments core PCE calculation apparently modified Federal Reserve Bank of Philadelphia president Anthony Santomero's reminder that "the Fed will have to continue shifting monetary policy from its current somewhat accommodative stance to a more neutral one." And some signs of softness revealed by Wednesday's report from the Institute for supply Management on business activity in the nonmanufacturing sector appears to have mitigated the expectation of another twenty-five in December, despite expressions of inflation concerns from Federal Reserve Bank of Kansas City president Thomas Hoenig. Overall, the estimated probability for a 25 basis point increase in December (on top of an assumed 25 basis points in November) fell by about nine percentage points, despite the hawkish-sounding comments that characterized the entire week.
I hasten to add that these estimates of market expectations are not necessarily inconsistent with the comments of Federal Reserve officials. Prices do reflect the opinion that continued "measured" funds rate increases are still the most likely outcome, by a long shot. But they do, I think, provide further evidence that folks in the know have a pretty clear idea of the implicit "rules" that guide monetary policy, and accordingly let the facts on the ground do the talking.
Here, for the record, is the data from the pictures above:
Download implied_pdf_november_100705.xls
Download implied_pdf_december_100705.xls
Download Imp_pdf_slides_for_blog_100705-II.ppt
UPDATE: The Big Picture has the graphs from the Wall Street Journal article.