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Ethan Harris

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The stronger data virtually assure significant changes in the Fed's directive this week, ... The new directive will probably include a grudging acknowledgement of the stronger labor market and inflation statistics.

Apparently the Fed's new policy of 'transparency' has taken the shock value out of monetary policy,

The number itself wasn't very surprising, ... (Federal Reserve Chairman Alan) Greenspan's comments last week that the trade gap might start getting smaller raised attention and some hopes. But I didn't agree with him about that.

There is a history both in appointments under the Bush administration and the Fed chairmanship itself of people off the list being picked. Bush does seem to have a proclivity to pick people with a more business background for his economic positions.

The combination of still-strong growth and rising inflation has prompted a string of hawkish Fed speakers all arguing strenuously for the need to keep inflation contained.

In an ideal world, three simultaneous gradual adjustments would happen. The U.S. eliminates the budget deficit, China revalues by 30 percent and China works to rebalance growth more to consumption and less to exports. Of course none of this will happen and the pressure for protectionism from Congress grows.

The reason the recovery was so feeble was you still had these hangover effects from the real estate and banking sectors. Real estate was still reeling from excess capacity and the whole thrift industry had been decimated by bad loans.

The markets are going to be a bit uncertain as to how to react, given that the Fed is waiting in the wings. They are all going to be looking ahead toward the FOMC meeting to see what the Fed's verdict is on the data rather than reacting as it comes out. They'll be sort of holding their breath.

Clearly the new focus of Fed attention is the stock market. The Fed is not focused on many of the indicators equity analysts emphasize. Instead, the Fed's focus is on aggregate wealth creation in the market.

If we have an economy that functions O.K., with a little help from the Fed, in that case gridlock is quite good for the market.

You probably want to subtract about two-tenths of a percent from first-quarter GDP growth. But that's looking like very old history, with the Fed having eased twice since the first quarter. From the market's perspective, you feel like you're in a different world already. The first quarter looks very distant, indeed.

Clearly, Corporate America is still in hunker-down mode, reluctant to increase budgets for equipment and slow about increasing employment. That puts a weight around the neck of the recovery and keeps it at a moderate pace.

[The CPI number] doesn't have a big influence in Fed thinking. This keeps [policy makers] comfortable where they are.

[By the fourth quarter], you will continue to have worries about corporate governance issues, a weak stock market and a buildup to war in Iraq leading to higher oil prices -- a lot of negative psychological forces in the economy that will make it very hard to sustain growth going forward.

The Fed's kind of locked into this cautious optimism mode. Everybody there has the same line about how once geopolitical risks abate things will get better.

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