Katrina is fading in the bond market’s rear-view mirror. Rates are back where they were two weeks ago, the 10-year T-note above 4.1 percent, mortgages 5.75 percent, save a residual bid in the 2-year T-note, placed by the few still hoping that Katrina will force the Fed to back off.

Give that up. Expect the Fed to proceed with another .25 percent on Sept. 20, Fed funds to 3.75 percent, and another Nov. 1 and Dec. 13, and continuing until the economy slows, housing first.

How can Katrina have had so little impact? Why no 9/11 follow-through?

9/11 itself, as a financial matter, lasted barely 90 days. The follow-on Fed easing and near-hit deflation were stock-bubble artifacts. The main economic impact of 9/11 was the total shutdown of Wall Street for 10 days, whereas the Gulf Coast is one of the weakest economies in the nation, on a par with Appalachia except for energy infrastructure. Were it not for energy (now either back on line or replaced by collateral circulation), Katrina would have had no measurable economic impact at all.

Yes, there are some 400,000 unemployed. Yes, the spike in retail energy costs has a slowing effect on the economy. But both are more than offset – way more, sez here – by the counter-flood of money spent and to be spent on rescue, relocation and reconstruction. If you count up all the R3 people at work around the country, it may be a bigger number than the unemployed; at least, better paid.

Insured losses may be in the $50 billion range, but cause no economic drag at all. Properly reserved losses cause no harm to insurance companies, just a post-storm surge of cash into the economy, paying claims. Congress has appropriated $62 billion so far, in one week, having no idea what for, but appropriated nevertheless. If you want something done fast, don’t call FEMA; nothing in government or physics moves faster than Congress when asked to give money away.

From the Fed’s perspective, the inflation consequences of the energy-price spike are more harmful than any beneficial slowing of the economy. Energy prices have calmed in the last week, but it looks as though we’re going to have three-buck gas for quite a while, and sky-high heating bills this winter.

New economic data have elevated the Fed’s inflation concern. Most event-shock (war, 9/11, natural disaster) makes obsolete any data preceding the shock. However, August employment data on Sept. 2 and the August service-sector purchasing manager’s report were both quite strong, much stronger than the widespread assumption pre-Katrina that the economy was slowing under the weight of a year’s Fed tightening and energy prices.

Labor cost data are beginning to show the worst-possible case for the Fed: energy-price pressure percolating into wages and diminished productivity. It took former Fed Chairman Paul Volcker and current Fed Chairman Alan Greenspan 23 years – 1979-2002 – and three recessions, to squeeze inflation expectations out of our economy. Those expectations had been created principally by Fed mismanagement of energy price shocks in the 1970s. At no matter what cost to the economy, the Fed is not going to repeat its 1970s error.

Not except for one possible outside intervention.

President Bush’s second term is a wreck, and Republican prospects in 2006 elections are deteriorating (propped only by the Democrats’ flinch from running on a Good Government platform – they know themselves too well). It may occur to Bush that appointing a compliant partisan to the Fed would be a good idea; instead of a recession in 2006, better to tolerate some inflation and fix it later, kinda like Iraq.

If Katrina’s legacy is a yes-man at the Fed, a John Snow type, then the storm will turn out to have been an economic disaster after all.

Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.


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