J.P. Morgan Funds' David Kelly: Do nothing, at least on the stance of monetary policy

On Tuesday the Federal Reserve's Open Market Committee holds its second meeting of the year to consider the direction of monetary policy.
APR 12, 2010
The following is a weekly commentary written by David Kelly, chief market strategist at JPMorgan Funds. On Tuesday the Federal Reserve's Open Market Committee holds its second meeting of the year to consider the direction of monetary policy. They will not lack for advice on what to do. However, the best advice is probably to do nothing, at least on the overall stance of monetary policy. Data released last week was heartening as it showed that, despite foul winter weather, economic activity is continuing to grow in the first quarter of the year. In particular, the retail sales report suggests that real consumer spending is climbing at a better than 3% annualized rate. This increased demand, combined with better weather, pent-up demand for consumer durables, and signs that the economy is now in net job creation mode, provides some assurance that the economic recovery is gaining a stronger footing, something the FOMC will likely to allude to in its post-meeting statement. At the same time, some numbers this week will emphasize just how far we are from a normally functioning economy. Industrial production appears to have seen very lackluster growth in February, while housing starts, at 600,000 units, remain about one million units below the long-term rate suggested by our demographics. Weekly unemployment claims, also are proving to be stubbornly slow in falling, and may remain above 450,000 in the numbers due out on Thursday. Meanwhile, the index of leading economic indicators for February, while expected to post its 11th straight gain, should rise by just 0.2%, consistent with only a modestly growing economy. Meanwhile, inflation numbers should be extremely tame with core consumer and producer prices rising by just 0.1% and headline numbers looking even weaker on a February decline in gasoline prices. The core consumer price index should be up about 1.4% year over year, showing the lowest underlying inflation seen in six years. In this environment, the dangers of an economic relapse and a descent into deflation are markedly greater than the risk of inflation, both in probability and in consequences. For this reason, and because of the need to further boost bank capital and bank lending, the Federal Reserve is likely to re-emphasize its intention to maintain exceptionally low levels of the federal funds rate for, in their words “an extended period”. A persistent risk facing investors is always that an unwise tilt in monetary or fiscal policy disrupts the economy. Hopefully, this week the Federal Reserve will provide reassurance that, at least for its part, it has no intention of making such a mistake.

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