A New Chapter Begins Today at the Federal Reserve and Soon at the European Central Bank

April 27, 2011

The heart and soul of FOMC statements for quite some time has promised low short-term interest rates and a policy consistent with its mandate of maximizing employment and and stable prices.  These passages are unlikely to be modified now and have said

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.

The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.

At the last policy meeting six weeks ago in mid-March, officials upgraded their views on job conditions and GDP growth, conceded higher inflation caused by commodity market strains, but asserted that longer-term inflation expectations continued to be stable amid subdued core inflation. 

The main focus for analysts combing today’s statement will be any clues about quantitative easing.  The second stage of such, dubbed QE2, has been almost completed, and analysts do not expect QE3 to be decided or announced now, since QE2 formally runs until late June.  There remain many question marks in the U.S. economy: the beleaguered housing market, weak consumer sentiment, a rising dollar that’s slowing export growth, and very elevated energy prices.  A cold turkey approach including letting the central bank balance sheet shrink by not replacing maturing government securities held by the central bank would carry risks.

Today will be an historic day for the Fed with the inauguration of post-meeting press conferences, a form of transparency already practiced by the European Central Bank.  The Fed will do this after half its eight annual meetings.  The ECB always holds a press conference, and those serve as a model for how to conduct oneself.  The ECB has had two presidents in its 12-year history, Wim Duisenberg and Jean Claude Trichet.  Trichet has mastered the medium of the press conference better than his predecessor, avoiding confusing gaffes and following a tighter script.  Trichet only answers those questions that he chooses.  Bernanke is not new to public appearances and Q&A formats.  He’s been a college professor, testifies before congress, and makes many speeches; in all these tasks, he’s shown an adeptness to avoid trouble and ability to think quickly on his feet.  One difference between Bernanke and Trichet is the former’s disinclination to lecture about fiscal policy, a topic that invariably arises in these venues.

 

  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 1.3969 81.04 3.29 11815 98.09
04/27/11 1.4662 82.31 3.35 12595 112.42

The above table compares vital market signs today to those at the time of previous FOMC announcements.  There have been important changes since the group met on March 15.  Oil costs 14.6% more now than then and 28.7% more than when late-January meeting was held.  The dollar has lost 4.7% against the euro since March 15, but the Dow Jones Industrial Average is 6.6% stronger.  And yet for all the warnings about a collapse of the Treasury market if Congress doesn’t get its house soon in order, 10-year yields have been remarkably steady as seen above.

A big change is coming to the ECB, too.  The Financial Times lead story today is that Mario Draghi, Governor of the Bank of Italy, is almost certain to be chosen as the bank’s third president of the European Central Bank, effective October.  Draghi is an anti-inflationary hawk, contrary to the stereotype of Italians being monetary policy doves.  He’s expected to be tougher than Trichet on banking supervision.  Unlike Trichet, he holds a PhD in economics from MIT, no less.  Besides experience as the Bank of Italy Governor since 2005, he’s been an economics professor, a Vice-President of Goldman Sachs, and Director-general of the Italian Treasury, a role in which he was instrumental in preparing Italy to join the common currency area.  If named, another swap among the 6-person Board of Directors is likely, swapping the current representative from Italy for someone of French nationality.  That would leave the Board with a member from Germany, France, and Italy.

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

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