Eye on the Kansas City Fed

We wanted to highlight the comments yesterday from Thomas Hoenig, the President of the Federal Reserve Bank of Kansas City, as it relates to the possibility of inflation raising its ugly head in 2009 due to the large amounts to stimulus and record low interest rates both in the U.S., and abroad. We’ve excerpted some key comments of Hoenig’s from a Bloomberg article below:

“Hoenig said the Fed 'must design an exit strategy that at the appropriate time removes excess liquidity from the economy and allows it to withdraw as a significant intermediary.'

Failure to do so risks bringing on inflation and financial market 'excess,' setting the stage for yet another crisis, he said.

Hoenig said on Wednesday that he believes deflation is not a 'large possibility' in the United States, and cautioned that inflation could resume its upward trend once the stimulus measures to jump-start the economy start to work.

Inflation has come down ... but with the stimulus that is in place and if the economy does in fact pick up toward the end of the year, I think we will have pressures up because policy is very accommodative at this time,' he added.”

His statement is supportive of one of our key themes for 2009, which is that the cost of capital will begin to raise in the back half of 2009 and into 2010. This is because basic math suggests rates can only go up, as they are at all time lows in the U.S. With Volcker as an advisor President Elect Obama, we only have to look back to Volcker’s time as Chairman of the Federal Reserve to see how quickly interest rates could go up if and when inflationary concerns emerge, which is graphically depicted below.

Daryl G. Jones
Managing Director