Business Blog Posts

The sharp rise in energy costs, precipitated by a wave of pro-democracy uprisings across the Arab world, could affect the economy in different ways, by retarding growth, boosting inflation or, in the worst case, both.

This complicates the terrain for policymakers, hardening long-held positions ahead of the Fed's March 15 gathering.

"The meeting has definitely gotten more interesting for the participants than they'd like," said Mitch Stapley, chief fixed-income officer at Fifth Third Asset Management.

"The stakes are rising," he said. "The nightmare scenario is some kind of stagflation outcome. That's some ways down the road but you begin to see that discussion emerge."

At the heart of the debate is the concept of economic slack, an attempt to measure the gap between current levels of activity and the economy's full potential.

The core of the policy-setting Federal Open Market Committee, led by Chairman Ben Bernanke, firmly believes broad price pressures are highly unlikely to overtake an economy plagued by high unemployment and meager wage gains.

A vocal minority of inflation hawks, however, are skeptical that the so-called output gap is a good determinant of U.S. inflation. If the monetary authorities wait for the country's 8.9 percent jobless rate to fall to more desirable levels, they say, it will already be too late.

This camp points to the Fed's massive expansion of credit to the banking system, including zero interest rates and $2.3 trillion in government and mortgage bond purchases to prop up credit markets hit by the worst financial crisis in generations.

The purchases have more than tripled the central bank's balance sheet and Philadelphia Fed President Charles Plosser calls it the "kindling" of future inflation.

In next Tuesday's policy statement, the Fed will likely manage this dissonance by acknowledging a recent pick up in energy costs but also reiterate that inflation expectations remain well anchored.

At this point, most analysts see the Fed completing its current $600 billion bond purchase program and calling it a day, even if the situation in the Middle East has widened the range of possible outcomes.

THE PSYCHOLOGY OF ECONOMICS

Unlike the European Central Bank, which recently hinted it could raise rates as early as next month, few believe Fed tightening is imminent.

"We still assume no interest rate hike until 2012," said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts. "The Fed is not the ECB. It will not raise interest rates just because headline inflation is rising."

Sri Lankan born Rajaratnam, 53, is the former head of the Galleon Group hedge fund that once managed $7 billion. He could face a 20-year jail sentence if convicted on the most serious charge of securities fraud.

Since arresting Rajaratnam in October 2009 and announcing charges against 26 former traders, executives and lawyers, the U.S. government has pressed ahead with what it calls the biggest probe of insider trading in the $1.9 trillion hedge fund industry.

Prosecutors allege Rajaratnam made $45 million in illicit profits through tips from former friends and associates. Nineteen people have pleaded guilty in the case, which stands apart from past insider trading probes because of the government's wide-scale use of phone taps.

The selection of a 12-member jury in Manhattan federal court is the first opportunity for prosecutors and defense lawyers to score points at trial after 16 months of jousting over wiretaps and other evidence. Opening statements will start once the panel is in place for a trial expected to last up to two months.

Rajaratnam is free on bail but fighting to stay out of prison in a saga involving leaked company secrets, phone taps and former friends, who will testify against him for the government.

It is not known whether Rajaratnam will testify in his own defense after the jury has heard hours of tapes and testimony from as many as six cooperating witnesses. Prosecutors say they could present up to 173 recordings of telephone conversations.

Among those who could be called by the government to testify is Lloyd Blankfein, chief of Goldman Sachs Group Inc.

Prosecutors and regulators have accused former Goldman board member Rajat Gupta of leaking information about the bank to his friend Rajaratnam, but Gupta has not been criminally charged.

Rajaratnam's chief defense lawyer, John Dowd, has fought hard for his wealthy client, arguing prosecutors have broadened the definition of insider trading. A money manager's liberty should not be at risk because he trades on a stock while knowing something about the company, Dowd argues.

He also fought, unsuccessfully, to suppress the FBI's secretly recorded phone conversations from trial.

"In some ways it sounds like a classic insider trading case," said Sam Buell, law professor at Duke University in Durham, North Carolina, who is not involved in the case. "But we can expect some kind of twist here in the nature of defense arguments about this is a different realm of trading and information sharing."

For the jury to convict Rajaratnam, the government must convince all 12 panel members that its evidence shows Rajaratnam knew he was receiving secret corporate information from someone who had a fiduciary duty not to disclose it.

The case is USA v Raj Rajaratnam et al, U.S. District Court for the Southern District of New York, No. 09-01184.

(Reporting by Grant McCool, editing by Matthew Lewis and Neil Fullick)