Fed Statement As Expected

December 16, 2009

Analysts weren’t looking for any remarkable initiative in the FOMC statement, and that’s what they got.  Economic conditions are better from the standpoint of the employment situation, income growth and financial market conditions, but officials reiterated that “exceptionally low levels of the federal funds rate” are likely “for an extended period.”  I’d bet this pretty conclusively rules our any rate change before the second half of next year.  The last tightening cycle began in late June 2004.  In the December 2003 statement, that is six months previously, the FOMC dropped an important clue that tightening was then on the radar screen.  Previously, statements from policymakers had stressed that the probability, though minor, of an unwelcome fall in inflation exceeds that of a rise, but for the first time in December 2003 officials instead said that the probability of an unwelcome fall in inflation had diminished and appeared almost equal to that of rise in inflation.  The communication of a policy reversal requires considerable lead time, and the Fed in that process is currently behind where it was at the end of 2003.

Each of the three conditions for retaining very low central bank rates relates directly or indirectly to inflation.  Conveniently, today’s U.S. CPI data did not contain an upside surprise as the PPI had done.  The Fed expects consumer price inflation to remain subdued, and why should it think otherwise?  With one of 120 months of CPI data remaining in this decade, core CPI has climbed at just 2.2% per annum for the period, down from 3.1% per annum in the 1990s, 5.7% in the 1980s, and 6.7% in the 1970s.  On-year core inflation in November was even lower at 1.7%, and both that figure and the past decade’s average pace compare favorably even with the 2.6% per annum trend in the 1960s.  Unemployment happens to be just two-tenths off peak and in double-digits for the first time in 27 years and only the second time since the Second World War.  Capacity utilization of 71.3% still has a long way to climb before reaching levels associated historically with generating unwelcome inflationary pressure.

The depiction of a gradually improving economy was also supported by data released today.   U.S. housing starts and permits rebounded smartly from October’s unexpected setback.  Global data were good, too.  Canadian manufacturing sales recorded their fourth increase in five months, a gain of 2.0% led by energy and aerospace that strengthens the view of an improving North American economy.  Europe’s preliminary purchasing manager readings were better than forecast in December and provided reassurance that momentum continued through quarterend in that region.  China, where growth next year should surpass 9%,  reported a 32% on-year jump in foreign direct investment inflows in November.  Even Japan announced a 0.5% rise in October of service-sector production.

The FOMC included a new paragraph with details of its intention to wind down special liquidity facilities within the next few months.  Plans are along expected lines, so again those revelations did not constitute a wake-up call for investors.  After the Fed’s statement was released, the dollar strengthened against the euro but slid against the yen.  Treasury yields firmed, and stocks settled back.  The moves were pretty inconsequential, however. Next up is the confirmation vote for Bernanke’s second term.

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



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