As we predicted, the Fed raised the Funds rate at its September FOMC meeting to 3.75 percent. We think the Fed will continue to raise the Funds rate at the November and December meetings, finishing the year at 4.25 percent and perhaps then pause to get a better reading on how recent events have impacted economic growth and inflation. Prior to Hurricane Katrina the economy was growing at a healthy pace with rising inflation, conditions that usually call for raising the Funds rate.

The impact of Hurricane Katrina will be negative for the economy, particularly in the short term. The immediate impact has been on oil prices, which have reached all time highs, and could be lifted further by the disruption caused by Hurricane Rita. Both storms took out significant amounts of refinery capacity. Another factor has been the curtailing of shipping flows due to temporary closure of the New Orleans and nearby ports.

The aftershocks from K-R will slow the U.S. economy. Most analysts call for a reduction of 0.5 to 0.7 percentage points in GDP growth during the second half of this year. We have reduced our 2005 GDP growth forecast to 3.1 percent, which is lower than the WSJ survey’s 3.5 percent. Our growth forecast has been consistently below the mainstream due in part to our view that higher prices, particularly energy, are cutting into consumer purchasing power.

The fiscal impact from K-R will show up in the budget for next fiscal year. We expect the fiscal 2005 deficit to end at $375 billion, down from $412 billion in 2004, but it could rise to $450-475 billion in fiscal 2006.

While inflationary pressures were already being felt prior to the events of K-R, we now see our moving average measure of the CPI reaching 3.5 percent by December of this year. The Fed’s FOMC statement issued after the latest meeting reiterated that "underlying inflation expected to be contained." However, by definition, underlying inflation will always be contained, since it excludes items in the consumer basket that are considered to be ‘volatile’ such as food and energy.

Housing prices have started to stabilize with housing starts beginning to weaken, after falling 1.3 percent in August.

With respect to the external accounts, the trade deficit continues to bulge in line with our prediction made at the beginning of this year of a $800 billion deficit for 2005. As we have said numerous times, the situation is rife for a notable downward adjustment to the value of the dollar. We still think the Euro could reach US$1.45 within the next six months due to the steep hemorrhaging in the U.S. balance of payments and the possibility that foreign investors may not be too keen on rolling over the U.S. external debt.

We think the combination of higher inflation, rising deficits, and expected volatility in the currency markets will begin to lift the long-end of the yield curve.

                                                Latin American Economies

In Bolivia, Evo Morales has pulled slightly ahead of Jorge Quiroga and Samuel Doria in the opinion polls for the presidential elections of December. Morales obtained between 26 - 28 percent of vote intention, Quiroga 22 percent and Doria about 12 percent.