Decision Time at the FOMC

March 15, 2011

The crisis in Japan has changed what the FOMC needs to do immediately even if the most likely scenario of ending QE2 in June remains the chosen script.  Foremost, U.S. monetary officials must do no harm to public psychology today.  This is not a time to tinker with the language of its statement with an intent to prepare investors for no quantitative easing after June.  The second round of asset buying by the Fed was foreshadowed by Chairman Bernanke at the Jackson Hole Annual Symposium in late August 2010.  The decision had been made because both of the Fed’s mandates of job maximization and price stability at a 1.5-2%  rate of price rise were not getting met.  The heavy lifting of QE2 was done by the time that the FOMC formally announced $600 billion of asset buying some two months later.  By then, the dollar had fallen 9.2% to 1.4017 per euro, and the S&P 500 had risen 12% above its level at the time when the chairman had spoken.  The 10-year Treasury yield was just 2.59%, slightly lower than in late August. 

While leaving itself the option to abort QE2 at any time if conditions, the FOMC until now has neither done that nor ruled out some extension of QE2 after midyear, although the policy has drawn criticism from outside the Fed and even among some policymakers on the FOMC in their individual public comments.  Oil prices are considerably higher now than last autumn.  After cresting back to 9.8%, the jobless rate has declined steeply to 8.9%.  Overall inflation is about a half-percentage point higher and above 1.5%.  The perceived risk last fall of an abrupt tightening of fiscal policy in 2011 was not exercised by the Congress.  The 10-year Treasury yield closed in New York at 3.55% a week ago, almost a full percentage point higher than on November 2.  U.S. GDP growth, which in the spring quarter of 2010 had slowed to 1.7%, had been more reassuring at 2.7% in the second half of the year, and analyst have revised forecasts for both 2011 and 2012 to growth of slightly higher than 3.0%. In the last FOMC statement on January 26, officials had taken a dim view of prospects for an improving labor market but nonetheless upgraded household spending to “picked up late last year” from “increasing at a moderate pace.”  Recent job market information had pointed to an upgrade of the labor market at this time, and that indeed could still happen.

However, Japan’s crisis has to get uppermost attention.  At this stage, it’s evolution and impact on Japan remain very uncertain, and the ramifications for the U.S. economy and financial markets are even further removed from any serious attempt at quantitative estimation.  If all financial markets stopped moving on fear, the damage would be limited, and it would appear appropriate for the Fed to end quantitative easing after June.  Since U.S. stocks peaked three weeks ago, they are down about 5-6%, much less than the drops of 20.6% in the Nikkei or over 11.0% in the German Dax.  However, Fed officials cannot assume that the reversal in markets has ended.  Conditions could get much worse, and it is unlikely that the FOMC will release a statement at 19:15 GMT today that throws investors a lot of hawkish red meat as the ECB did earlier this month.

The table below provides the evolution of key market indicators thought the chronology of past FOMC meetings.  Quotes are those taken at the moment when FOMC statements were released on the days indicated.  The Fed funds target has been zero to 0.25% since December 2008, and the Committee has persistently adhered to conditional language that predicts “exceptionally low levels… for an extended period.”

  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 1.3423 83.37 3.38 11497 88.47
01/26/11 1.3658 82.55 3.41 12001 87.36
03/15/11 1.3957 80.90 3.29 11786 98.57

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.

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