Rating the Future: No rate hikes is the pretty picture.

National Review Online ^ | April 22, 2002 | Larry Kudlow

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Alan Greenspan's testimony last week sedated the manic bond traders who had the fed funds futures rate — which is often used to predict the central bank's key federal funds rate — running up to 3.5% by year-end. Now the futures market is predicting a 2.75% December funds rate. That's better, but the bond crowd might want to look a little lower.

There is a significant likelihood that the fed funds rate — which the Fed has held steady since December at 1.75% — might not rise at all this year. The Fed is going to wait to watch employment rise for six to nine months before they make a move. And in supply-side terms, none of the inflation-sensitive market-price indicators show excess money in the system, which would prompt Greenspan to ratchet up the rate. Hence, with the economy rebounding so smoothly, a rise in the funds rate won't occur until the fourth quarter, if at all. And then by only 50 basis points.

Another factor that could help generate a calmer, less interest-rate-tinkering Fed, is Ben Bernanke. He's the chairman of the Princeton economics department, and according to media speculation he's a shoo-in for one of the two open seats on the Fed board. Bernanke favors an inflation target rule, and this would be a promising reform for the central bank. The forward-looking financial and commodity-price indicators would make even better targets, but an inflation rule would still be an improvement over the Greenspan standard: acting on whatever he's thinking as he steps out of the bathtub in the morning.

Another name surfacing for an empty Fed seat is Robert McTeer, president of the Dallas Fed. Hallelujah! For many years, on the air and in print, I've been pushing McTeer for Fed chairman. While it would be better to hear his name discussed as the lead candidate to replace Greenspan when he retires, a Fed seat might bring McTeer closer to the throne. He's a technological-gales-of-creative-destruction follower of Joseph Schumpeter, the legendary economist and critic of Marx and Keynes. He looks at real-time market prices and monetary trends, not lagging indicators. He opposes speed limits to growth. In short, he's just what the Fed needs.

Yet, even without these seats being so fortuitously filled, the bond traders have cause to be calm. There are simply too many positive signs out there for even Alan Greenspan to be jumpy. This still looks to be an inflationless recovery, with a 4% pace for real GDP and about 1% inflation. With strong productivity, it should be a very positive year for corporate profits, too. The only real worry is oil, where prices have spiked roughly 50%, mostly due to the political chaos in Venezuela. Now, if the Bush administration were to unleash the CIA on oil-unfriendly Venezuelan President Hugo Chavez, who wants to take over the state-run petroleum company in order to send money to his pal Fidel Castro and to Colombian terrorist and drug-running guerrillas, that would be a supply-side blow for world economic growth. But for the time being, let's bank on a placid Fed. No rate hikes is the pretty picture.