He can't raise interest rates, as that'd cause the housing industry, already in full historic meltdown, to meltdown even faster.
But if he can't raise interest rates, the the dollar sells off and inflation could get ugly.
Well, the market has called his bluff now. The dollar is in free fall because they know he won't raise 'em. The yield curve is inverted. The bond market knows for a fact that a housing-led recession is underway. And the end game is now here.
The Fed Cries Wolf; Mr. Market Isn't Listening
Nov. 29 (Bloomberg) -- Federal Reserve officials are getting a first-hand lesson in the law of diminishing returns: Try as they might, they can't seem to get the same mileage from their hawkish rhetoric.
In the past few months, every time a policy maker found a waiting platform, he or she used the opportunity to remind us that the Fed is more concerned about rising inflation than slowing growth.
Their words had predictable results. The prices of interest- rate futures contracts that reflect expectations of Fed policy sank, wiping out the gains registered on weak economic data.
Then something strange happened. The market stopped listening.
While June Eurodollars have yet to scale their former heights, they haven't revisited their September/October lows in the face of repeated reminders of the risks of inflation from the Fed.
The current inverted shape of the yield curve, with long rates lower than the funds rate, reflects the bond market's view that short rates are unsustainable at this level.
Does the market know something the Fed doesn't know? It usually does. Bernanke may be smiling, but on some level, he has to be concerned about the message he's receiving loud and clear.
November 29, 2006
Posted by blogger at 11/29/2006