FOMC Statement and the Dollar

October 29, 2008

The FOMC voted unanimously to do what most analysts expected, cut the Fed funds target and discount rate by 50 basis points to 1.0% and 1.25%. The released statement suggests a continuing bias to cut rates. It reads more dovishly than the statement from the prior pre-scheduled meeting on September 16th, which had been held shortly after the failure of Lehman Brothers. A reference to a “substantial easing of monetary policy” in the release on September 16th is no longer included in the text. Officials in mid-September predicted actions taken would “promote moderate economic growth” over time. That hope is put less strongly today; the new statement talks instead of “a return to moderate economic growth” and links such to “improved credit conditions” over time. For many meetings including the one in mid-September, officials expressed a belief that inflation would moderate but hedged that bet by maintaining that the “outlook for inflation remains highly uncertain.” When the Fed joined other central banks on October 8th, cutting rates by 50 basis points at an unscheduled meeting, the statement removed the reference to an uncertain inflation outlook but still spoke of upwardly skewed price risks, which have been reduced. This time, officials plainly assert their expectations that inflation will “moderate in coming quarters to levels consistent with price stability.”

Any residual need to balance two somewhat competing priorities — supporting growth and preserving stable prices — has now been discarded. A conflict no longer exists, explicitly or implicitly. The statement is bearish about growth, not merely noting a marked slowdown in activity and weakness in every component of demand, but predicting that intensifying “financial market turmoil is likely to exert additional restraint on spending.” So the downturn will get worse, and “downside risks to growth remain.” Finally, officials promise to “act as needed to promote sustainable economic growth and price stability.” If their thinking proves correct and both inflation and growth weaken, the promise suggests additional moves closer to a policy of zero interest rates and perhaps beyond.

The U.S. currency had softened earlier today in anticipation of a rate cut. However, by 19:10 GMT or slightly less than an hour after the rate announcement, the dollar was showing pretty insignificant net movement, with a loss from 10:45 GMT of 0.4% against the euro and no change versus the yen. This is a typical reaction. The previous eight days of this easing cycle on which the FOMC reduced rates mostly elicited little response from the dollar as well. The biggest movement against the euro was a rise of 1.0% on March 18th, and half of the instances saw a move of 0.6% or less. The dollar advanced 2.2% on March 18th and fell 1.2% on December 11th. On five of the other six dates, dollar/yen movement was smaller than +/- 0.5%.



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