Philly Fed Pres Plosser Says "Damn The Torpedoes" Isn't Good Policy...

Finally a man with some sanity!  While speaking to a business group in Alabama this morning, noted inflation hawk and president of the Philly Fed, Charles Plosser, sounded the alarm that "there are those who have expressed the view that in times of economic weakness, the Fed must not worry about inflation and should focus its entire effort on restoring economic growth by dramatically driving interest rates down as far and as rapidly as possible." He warned that this "damn the torpedoes, full speed ahead" type of policy "risks undermining our ability to achieve economic growth over the long run," and "cannot solve the bad debt problems in the mortgage market. It cannot reprice the risks of securities backed by subprime loans. It cannot solve the problems faced by those financial firms at risk of being given lower ratings by rating agencies."

The most noted take away from his remarks, however, were in regard to inflation and the Fed's ability to maintain credibility. Plosser noted that "so far inflation expectations have not changed very much. But they bear watching because there are some signs that they too are edging higher. These may be early-warning signs of a weakening of our credibility, and we must be very careful to avoid that." Well those remarks sent the market heading south quickly as any insinuation of taking away our beloved rate cuts completely freaks the market out...especially when you couple those hawkish remarks with words like "weakening of our credibility."

While the market may believe it simply wants rates cut as fast as possible, I continue to believe (as Im sure you'll recall from yesterdays blog) that the Fed's number 1 priority right now should be regaining credibility. The Fed can cut rates all it wants, but if it loses credibility, Americans will eventually find themselves jobless, yet paying $5/ gallon for milk and a gallon of gas. Its called stagflation, and it very much may be a reality in the next few years if the Fed doesn't do its job correctly. We must recall that the purpose of the Federal Reserve is not simply to appease financial markets, but rather to maintain price stability throughout the economy over the long run. Hence, this is why the Fed is almost always intensely focused on inflation expectations, as once they get out of hand it must drastically adjust monetary policy for fear of allowing its most dreaded enemy to arise....hyperinflation. Once this takes hold it is extremely difficult to work an economy back to stable ground without severe consequences.

While Plosser's hawkish remarks may have been in response to yesterdays call by Merrill that the Fed may be gearing up for yet another inter-meeting rate cut, they did little to dampen expectations of future rate cuts, with Fed Funds futures continuing to price in a high probability of a 50bp rate cut at the next Fed meeting in March, and still pricing in a 1/3 probability of an inter-meeting rate cut.

Either way it is good to see that there is some semblance of sanity within the Fed...we may have some hope of getting out of this alive after all.