Tuesday, March 28, 2006

Has the Fed Gone Too Far?

For the 15th straight time, the Fed raised its target for the fed funds rate by 25 basis points. The new target is 4.75%. Has the Fed gone too far?

Here's what we know: The housing market is slowing. Inventories have taken a big jump on both coasts. Prices haven't yet declined, but if inventories remain high, prices will fall. Home builders are already ratcheting down earnings projections. We also know that home-price appreciation has fueled consumer spending to a large degree in recent years. With the end of the housing boom likely, consumer spending growth will also slow.

We also know that energy prices are way up, yet so far there is virtually no evidence that higher energy prices have resulted in inflation. If anything, higher energy prices appear to have drained disposable income, leaving consumers with less money to spend on other things.

Except for a few sentences in the first paragraph, today's statement was identical to the one issued on Jan. 31. The Fed assures us that inflation expectations are contained, yet warns us about elevated energy prices and says further tightening may be needed.

If there isn't much evidence of inflation, as the Fed claims, why does it keep raising interest rates? Either the Fed has already gone too far, or it knows something it isn't telling us. My guess is that the Fed is convinced that it is only a matter of time before higher commodity and energy prices result in higher inflation. I believe the Fed will keep raising rates until the yield on the 10-year note jumps to 5-5.5%. The danger is that the 10-year yield may suddenly jump higher.

We'll be discussing this issue and more on tonight's Kudlow & Co. on CNBC.