FOMC Day

December 14, 2010

By a vote of 10-1, the FOMC at its November 3 meeting decided to buy $600 billion of longer-term Treasury securities, averaging $75 billion per month from November through June 2011.  Even then, undertaking a second round of quantitative easing, dubbed QE2, was a controversial decision.  Minutes from the November meeting and confusingly mixed rhetoric from central bank officials suggest that the formal vote masked the degree of internal concern about risks associated with the program, and these worries may have intensified.  The point of QE2 was to depress long-term interest rates, but the 10-year Treasury yield increased by 22 basis points over the balance of November and by a further 58 bps so far this month. 

The November FOMC announcement came a day after an election of protest against incumbents and Democrats in particular.  The Obama Administration and congressional democrats are not the only ones in the cross-hairs.  So is the Federal Reserve.  With determination that would make Andrew Jackson proud, Ron Paul, tapped to chair the Financial Services Committee, is on a crusade to clip the Fed’s powers and independence.  In this context, central bank officials have no choice but to weigh the political ramifications of every move it makes. 

U.S. fiscal policy will be much more stimulative next year than Fed officials were anticipating when QE2 was launched.  The U.S. stands alone in this regard with a package of measures moving through congress that will approach the thrust of the stimulus that was passed early in the Obama presidency.

Economic data released by the United States have been much more reassuring since November 3rd.  Third-quarter GDP growth was revised upward from 2.0% annualized to 2.5%, and fourth-quarter growth seems likely to surpass 3.0%.  Despite continuing elevated unemployment, consumer confidence and spending show greater vitality.  Retail sales leaped 1.7% in October and rose by a further 0.8% in November, and that wasn’t all due to higher energy prices, either.  Chain store sales suggest decent holiday shopping sales.  In October exports rose 3.2% versus a 0.5% drop in imports, and the volume trade deficit was nearly 10% narrower than its 3Q mean.  Factory orders in October took a 0.9% step backward but had risen 3.0% in the prior month.  The purchasing manager indices in November of 55.0 in services and 56.6 in manufacturing were decent, and the Fed’s own Beige Book identified only two of twelve districts as having been mixed or worse compared to the prior survey.  Labor productivity advanced by a brisk 2.3% last quarter.  The biggest data disappointments of the past six weeks were in housing and the Labor Department’s jobs report.  Increases of only 39K in total jobs and 50K in private employment seem to be anomalies, as such were not consistent with the more upbeat tone of other statistics including other labor market indicators.  New jobless insurance claims of 427.5K on average over the four weeks to December 4 were down from 446.5K in the previous four weeks and 459K in the four weeks to October 9.

The Fed cannot afford the public relations fallout of retreating from the $600 billion QE2 size so soon after beginning the program.  Such indecision would play into the enemy hands of the central bank.  Instead, the statement later today will probably acknowledge the better growth outlook, stress the continuing need for insurance against excessively low inflation, and suggest perhaps a lessening need for more quantitative easing beyond what’s been outlined already.  Central bank officials may also wish to tie their policy to levels of activity, which remain historically depressed, rather than rates of growth.

The table below documents vital market prices at the time of previous FOMC announcements.  These quotes are compared to those existing as officials now meet.  Their decision is expected around 19:15 GMT.  The biggest shocker is an 86-basis point increase in the ten-year Treasury yield since November 3rd.  This in turn has lifted the dollar by 5.1% against the euro but only half as much against the yen.  Oil prices are 4.5% more expensive now than then, and gold has appreciated by a similar 4.4%.  The Dow Jones Industrial Index has risen 2.8% on balance.

The fed funds target has been at 0-0.25% since December 16, 2008, that is for two whole years.  Did somebody say, “it’s beginning to look a lot like Japan?”  In the previous tightening cycle, the funds rate was raised by 25 basis points at 17 consecutive meetings from June 2004 to June 2006.

  EUR/$ $/JPY 10Y, % DJIA Oil, $
06/30/04 1.2173 109.44 4.63 10396 37.95
06/30/05 1.2090 110.89 3.96 10370 57.00
06/29/06 1.2527 116.07 5.20 11077 73.41
06/28/07 1.3452 123.17 5.10 13456 69.82
08/07/07 1.3749 118.55 4.73 13510 72.27
09/18/07 1.3888 115.75 4.51 13475 81.42
10/31/07 1.4458 115.28 4.42 13873 93.59
12/11/07 1.4682 111.49 4.11 13645 89.78
01/30/08 1.4792 107.31 3.70 12454 91.70
03/18/08 1.5786 98.73 3.41 12257 107.53
04/30/08 1.5562 104.58 3.83 12953 111.54
06/25/08 1.5568 108.37 4.18 11837 133.62
08/05/08 1.5445 108.42 3.97 11484 119.82
09/16/08 1.4144 105.16 3.36 10936 91.18
10/08/08 1.3625 99.87 3.50 9447 87.02
10/29/08 1.2933 97.15 3.81 9145 67.38
12/16/08 1.3790 90.14 2.52 8687 44.14
01/28/09 1.3253 90.01 2.61 8356 42.92
03/18/09 1.3115 98.13 2.94 7340 47.73
04/29/09 1.3331 97.06 3.02 8194 51.05
06/24/09 1.3984 95.43 3.59 8373 68.76
08/12/09 1.4221 96.17 3.71 9366 70.64
09/23/09 1.4779 91.50 3.50 9859 69.13
11/04/09 1.4884 90.75 3.51 9896 80.66
12/16/09 1.4542 89.78 3.56 10478 73.14
01/27/10 1.4045 89.49 3.61 10148 73.31
03/16/10 1.3756 90.64 3.67 10645 81.45
04/28/10 1.3157 94.10 3.75 11043 82.57
06/23/10 1.2284 90.12 3.13 10307 76.50
08/10/10 1.3107 85.85 2.81 10605 79.94
09/21/10 1.3132 85.21 2.66 10747 73.05
11/03/10 1.4059 81.35 2.53 11174 84.59
12/14/10 1.3375 83.53 3.39 11484 88.36

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

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