Fed Forecasting Slowdown in 2008

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I am thinking about renaming the Federal Reserve “Team Obvious” for their latest round of forecasts; which call in part for a slowing of the economy in 2008. Wow, it’s nearly December 2007 and things look pretty terrible; thanks for the heads up. This data of course is courtesy of the more “transparent” Fed with new 4-times yearly outlook statements meant to enhance our understanding of Fed decisions in the interim between brief meeting minutes.

From a Market Watch article:

At the meeting, the FOMC cut short-term interest rates by a quarter-percentage point to 4.5% but moved to a “neutral” stance by saying that the risks of a severe downturn and a spike in inflation were in balance.

That statement shocked Fed watchers, who took it as a sign the central bankers do not want the market to get accustomed to rate cuts at every formal meeting. Several speeches from Fed officials also suggest the Fed want to hold rates steady at their next meeting on Dec. 11.

The forecast released today suggests the central bank is actually optimistic about inflation.

Here is where I have the problem – how is the Fed optimistic about inflation? Barry Ritholtz at The Big Picture writes constantly about how the inflation picture is skewed to begin with; as we’ve had massive run ups in energy costs ($100/barrel oil anyone?) health care (my premium is ridiculous, yours?) and food (have you looked at a box of cereal lately?) are totally left out of the inflation picture.

Then add on top of that the pressure that lower rates cause and you have “real” inflation (vs. government defined inflation) at much higher levels taking real dollars out of your real pocket. And for giggles lets throw in the totally tanking dollar which makes our “real” worth much less than the number of dollars we have in our pockets.

Some more to chew on:

“FOMC members were more persuaded than they had been in June that the decline in core inflation readings this year represented a sustained albeit modest step-down rather than the effect of transitory influences,” the Fed forecast said.

Inflation is expected to remain contained. Headline inflation, as measured by the PCE index, is expected to slow to 1.8%-2.1% in 2008, down from around 2.95% this year. Core inflation will remain steady in a range of 1.7%-1.9%.

Fed officials cut their growth forecast in 2008 to a range of 1.8% to 2.5% next year, down from the previous forecast of 2.5% to 2.75% released last July.

I have a hard time believing that the economy will continue to grow at that pace. With that said, if economic growth weakens significantly the Fed will be forced to cut rates further which will raise inflation pressures. I don’t see the Fed standing pat as the economy tanks and I think that further cuts will simply fuel a weakening dollar and rising inflation which will cause long-term lending rates to rise.

Basically, I think the Fed is looking at a situation that will make it difficult for them to win regardless of the actions they take. Is that overly pessimistic? Hopefully. But the fundamentals remain that:

Americans are losing spending power as equity dwindles
There are a glut of homes on the market
Costs of important goods are rising
Dollar value is weakening
Long term interest rates are stubborn and not necessarily tied to Fed cuts
Debt markets are still in shambles making financing anything difficult

As long as those fundamentals remain Team Obvious will be right in their 2008 assertion; I just hope it gets resolved by then, but looking at the wave of Option ARM resets and more make me think that we are free to push that gloomy forecast out a few years with out much worry about looking foolish.

What do you think?