State of the Union vs. FOMC

Because the writer strike is still going on, the discussion around the water cooler this week may turn to a critical analysis of the State of the Union address vs. the Federal Reserve announcement on interest rates and the accompanying statement. My guess is that the Fed will win hands-down.

President Bush walked into the chamber (a colleague of mine cries when he sees this pomp and circumstance) knowing that his final address to the nation would be a tough one. He faces rock-bottom approval numbers with 11 months to go in a lame duck presidency. The pre-game buzz was that the President would emphasize the weakening economy, especially now that it has become top on the list of voters’ concerns. Instead, he chose to concentrate on the defining issue of his presidency: the war in Iraq. Score one for consistency, but I’m guessing that people wanted to hear something more creative than what boiled down to “let’s make all of the tax cuts permanent.”

The current economic malaise is better material for Ben S. Bernanke (BB), Chairman of the Federal Reserve. We will hear whether the Fed will follow last week’s surprise three-quarter of a percent rate cut with another ¼ or even ½ when the central bankers finish their meeting this afternoon. Investors are watching every move that the Fed makes and of course, we are all judging every micro-step along the way. My two cents is that the Fed is getting to the right place on rates, but for the wrong reasons.

It now appears that only when the Fed got spooked by falling markets, did the bankers determine that they were behind the curve on tightening amid a weakening economy. Unfortunately, that is exactly what Bernanke was trying to avoid when he held firm on rates for so long in the face of deteriorating financial conditions. You could almost hear him saying to himself, “I am not going to be a patsy—they think they know what I’m going to do, but I don’t have to ratify expectations to appease them…I am my own man, darn it!”

I am not quibbling—I am just happy that we are getting there, but with the last move, BB may have sealed his fate as “Greenspan II”---a central banker who is more content to allow inflation to bubble up than to be seen as an anti-growth, inflation hawk. While that may be BB’s true disposition, I can’t figure out how there will be rampant inflation at the same time that two compelling, deflationary forces are at work: a deep housing recession and a credit crisis. Both of these factors should eventually help contain inflation, despite what the gold bugs say.

If BB gets us through this period with limited damage, he will still face scrutiny and opposition. There will be those who note that by not allowing a more pronounced clearing out of excess, BB has sewn the seeds of the next bubble. Considering that the US economy has now lived through two bubbles in eight short years, does this mean that the next one will have even more dramatic results? Time will tell…