FOMC Statement: No Rocking the Boat

August 12, 2009

Today’s FOMC message is that it will be quite a while still before rates are raised.  The intensity of quantitative easing (QE) is already diminishing, and the Treasury buying is set to end in October.  The clause about making adjustments to these programs “as warranted” could be a two-edged sword, as they leave open the option of more asset buying operations in the future if the situation were to deteriorate.  That’s not the baseline forecast, however, so is apt to end before a rise in targeted rates begins .

With a notable exception, Today’s statement from the Federal Open Market Committee had virtually the same things to say about the change in economic and financial market conditions between June 24th and August 12th as had been observed about the period between April 29th in June 24th.  The message is one of a transition into stability, and the contributions toward that process from major components of demand proceeding as such did before.  That is, what the FOMC had to say about personal consumption now, for example, is pretty much the same as its comment in late June.  The notable exception is the passage of time, which moves the economy further into its transition from a “somewhat slower pace of contraction at end-April to a “slowing” pace of contraction in late June to a point now where “activity is leveling out.”  Leveling out still connotes stability, not recovery, and the Committee still projects “weak” activity “for a time” as it did in its April and June statements.  Meanwhile, financial market conditions, which were “easing” in April and “generally improved” by late June, are now “improved further.”  Again officials are describing a process. The tipping point still lies in the future, from recession to expansion and from dysfunctional financial markets to normal ones.

The language on price pressures was not changed.  Unlike its critics, the FOMC is not worried about accelerating inflation.  It will be addressed in time but does not pose a present danger.  The message on prices rests on an implicit output gap model, where the level of activity is more important than than the rate of change in that level and where monetarist worries about rapid money stock growth when occurring with full employment.  Most central banks utilize a framework with these concepts playing a central role, even the ECB which factors in monetary analysis primarily a a means of controlling expected inflation.  The FOMC has not backed away from its view that “inflation will remain subdued for some time.”

In conjunction with an economy that hasn’t yet begun to recover, the view on inflation leads to the repeated revelation that Fed officials still anticipate “exceptionally low levels of the federal funds rate for an extended period.”  With almost five-eighths of 2009 completed, that strongly suggests no abandonment of near-zero rates before 2010.  While the FOMC has a history of policy turning points at its late-January/early-February meeting, that date also seems too soon.  Actual GDP at that time will still be far beneath potential GDP, and the balance of pressure on core inflation will still be downward and fairly strongly so.  The Fed’s wording also suggests that it will start the rate-rising process with a small 25-basis point step as it did in 1988, 1994, 1999, and 2004.  At some point, however, I agree that it will become imperative to move routinely in larger-sized increments.

The gestalt of the Fed’s remarks leaves a reassuring impression, and it’s not surprising that both bonds and stocks rose in the first hour after the central bank announcement.  The Fed is not making noises about a lurch toward tightening.  It will be done gradually at first, and the funds rate isn’t likely to budge for six months or more.  Subdued inflation buys the Fed time, even as the economy and financial market functionality continue to move in the correct direction.  The policymaking committee voted unanimously, so there is no internal dissension to unsettle investors, and the statement does not use the word “uncertainty,” a euphemism for chaos heard often earlier this year.  Finally, the statement promises to pay attention to the central bank balance sheet.  That might strike many as lip service, but it’s a wise and calming phrase to have inserted.  Investors cannot yet see clearly on this rainy afternoon in New York, but better days are anticipated.  The Fed was not about to rock the boat at this delicate stage.  All it would take is a major downward correction in equity wealth to reverse improvement on many fronts.

Copyright Larry Greenberg 2009.  All rights reserved.  No secondary distribution without express permission.

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