The Federal Open Market Committee almost certainly voted to ease monetary policy last week, with Chairman Volcker voting against this "snugging down" of the fed funds rate, to 6 1/2% from the 6 3/4% that had been the target since late May. The target in March and April had been 6 3/8%. We don't have any information on whether Volcker was joined by any of the other governors, but assume some of the regional governors stayed with him on this, his last FOMC meeting. There are rumors in the bond market that he will not testify next week on the mid-year Humphrey-Hawkins targets, and he probably won't, we're told, but not because he was in the minority. He doesn't want to cramp Alan Greenspan, who may soon be going before Senate Banking on his confirmation hearings.
We think the easing was premature, that it muddies a monetary picture that had begun to look much better during June, with the dollar strengthening steadily against the yen, the price of gold drifting lower by daily dimes and dollars, and the bond market firming at the same rate. The rationale seemed to be that things were going so well that the Fed could reward the markets with a reversal of the May snugging up on fed funds. Where we had thought a steady course at the FOMC would continue to bring improvement on long rates, as the gold inflation signal dipped, now we're likely to be on a knife edge, $450 gold, a 150 dollar/yen rate, the long bond around 8.6%.
One report that came to us was that Volcker could have prevented the snugging down if he had taken the lead at the FOMC. But he spoke last, after the other governors had committed themselves, simply warning that they had made a mistake. The errors creeping into monetary policy coincide with the revival of attention being placed on the monetary aggregates, growing at a slower rate than had been projected — precisely because the Fed let the demand for dollars decline in April-May without timelier snugging on short rates. This snugging down will have the opposite effect on the M's than anticipated. Would Greenspan have voted against this marginal easing? Probably not, going along with the other Reagan appointees in misinterpreting the aggregates and preferring a weaker dollar for trade purposes.
Without further change in monetary policy, the dollar would sink with adverse news on trade protectionism, and vice versa. The more protectionist the trade bill becomes as it develops in the Senate-House conference, the better the markets will respond, on the assumption it will be vetoed and killed. The more it is compromised and diluted, the worse it will be for stocks and bonds, suggesting Howard Baker, Malcolm Baldridge, etc., will try to persuade the President to sign the legislation. The bond market would be hit hard with a trade bill enacted and signed, especially without Volcker at the Fed to argue for a dollar defense. We are assuming that Treasury Secretary Baker prefers no trade bill and that is still the likeliest outcome, with the President being sustained on a veto later in the month. It was not encouraging to hear the Fed so eager to relax, so soon after finally acting with firmness. But surely there will be a swing back if gold jumps and the dollar slides again. Our fingers are crossed.