After the Fedís aggressive 50 basis point hike in the funds rate this past month, two things appear certain. First, the Fed will probably tighten once more. Second, the U.S. economy will slow. The only questions on both those counts are when and by how much. The next Fed meeting is scheduled for June 28. Although a 25 basis point is most probable, there are two other possibilities: they do nothing or they could hike rates another 50 basis points. How for the Fed goes will be determined by the economic data. The economy appears it has already begun to moderate because consumer and construction spending are slowing. Consumer spending in the second quarter is growing at about half the rate as in the first quarter. Other data for April and May showed that in many ways a downshift in economic activity is under way. Most notable were declines in retail sales, durable goods orders, existing home sales, and new home sales. With the equity market down for the year-to-date, the wealth effect has dissipated. That suggests that consumer spending will be constrained by income. Income growth has slowed to about a 4% pace and some further slowing is likely. Just another reason the Fed wonít have to go much further.

Not until the most recent tightening have the financial markets finally begun to react in a fashion more typical of a restrictive Fed. This, in turn, is helping to slow liquidity growth further, and bring about the moderation in economic activity that the Fed aims to achieve. As we see inflationary pressures soften, short-term rates will begin to move lower. This will also cause spreads between Treasuries and agencies tighten. Agencies have already begun to tighten in the nine to twelve month time frame.