Despite its obvious concerns about inflation, the Fed is widely expected to leave rates unchanged at Tuesday's policy meeting. The weak housing market, rising unemployment, and ongoing stress in the credit markets will prevent the Fed from aggressively trying to tame inflation for the foreseeable future.
Indeed, while futures traders are pricing in high odds of a rate hike before year-end, Beth Ann Bovino, senior economist at Standard & Poor's, says the Fed can't do much more than talk tough about inflation now.
Bovino believes the economy is currently in recession, calling the weak 1.9% second-quarter GDP the "tax-rebate high" for the cycle. Even this morning's higher-than-expected consumer spending data shows why that 1.9% growth was likely an aberration; "after adjusting for inflation, real consumer spending was actually down 0.2% following a 0.3% gain in May," The FT reports.
S&P believes the recession will most likely be "long and mild," similar to the 2001 downturn. Her big concern is there's "no bottom" in sight for housing, which S&P doesn't believe will bottom until the second half of 2009 at the earliest.
Bovino believes the central bank will tighten as soon as there's evidence the economy is stabilizing, most likely in the second or third quarter of 2009. But the Fed's need to address inflation could stifle any recovery before it gets a chance to flourish; that's one big reason why Bovino thinks the recession will be "long" and admits the downturn could ultimately be a lot worse than "mild."