An FOMC Experiment in Transparency

January 25, 2012

Today is FOMC Day, and it will be like none before it and Federal Reserve officials elevate policy communication to new levels.  A typical FOMC statement will be published at 12:30 EST (17:30 GMT), and Chairman Bernanke begins a one-hour press conference at 14:15 EST (19:15 GMT).  New macroeconomic forecasts are scheduled for 4Q12, 4Q13, 4Q14, and the longer run.  The novel elements in addition to these January staples will be 1) a second statement describing the FOMC’s longer run policy objectives, which is expected to in effect indicate a medium-term inflation target of around 2%, 2) an indication of the expectation distribution among FOMC members of when the first interest rate hike is likely to occur, and 3) an indication of the expectation distribution for how quickly rates are likely to thereafter increase.

Indications of U.S. demand and activity have improved since the FOMC met in mid-December.  The labor market has looked healthier, particularly from the standpoint of jobless insurance claims.  Overseas, the euro debt crisis continues to pose enormous contagion risks, but the associated level of fear has simmered down somewhat since the ECB’s huge three-year refinancing operation.  The first paragraph of today’s policy statement will acknowledge these changes, but it’s doubtful that officials will drop mentioning that unemployment is still "elevated," a characterization adopted last September.  The remarks on price pressures will again stress that actual and expected inflation are low. 

All this will enable the statement to repeat the view that both of the FOMC’s mandates are being missed in a way that warrants a continuing adherence to exceptionally low levels of the federal funds rate at least through mid-2013.  The lack of deterioration in conditions, however, rules out any temptation to expand unconventional stimulus.  Two rounds of quantitative easing have been completed, and Operation Twist, which doesn’t boost the balance sheet but will lengthen the maturity of Fed asset holdings and exert downward pressure on rates at the longest end, will not be completed until June.  There’s no reason to pre-announce an extension of Operation Twist now.  Having cut rates to near-zero and raised the balance sheet to a point where costs might outweigh benefits, the cutting edge of policy has moved to the ways in which policy is communicated, with the objective to convincing investors to push outward their expectations of when policy might start to be normalized.

I’m of two minds about the reaction to the jump in new information that will be provided today.  One is that it’s overkill and will only serve to confuse investors with conflicting and ambiguous signals.  The other is that the information could take a step to quantifying how much longer beyond mid-2013 the Fed funds target will stay at 0-0.25%.  The mid-2013 date from its introduction was qualified by "at least," thus suggesting that was the earliest possible date of change assuming that inflation stayed contained.  If the body of information today implies that a tightening is unlikely before 2014, that would constitute a fresh piece of meaningful news.  And there are a number of reasons to suspect that Fed tightening will not begin as soon as the middle of next year.  Heavier U.S. fiscal restraint is on its way.  Consumer spending has again been outstripping income growth in an unsustainable way.  External demand will be slowing.  Risks to growth appear skewed to the downside, contrary to the better tone on data since the last FOMC meeting. 

The table below shows market vital signs at the release time of previously scheduled FOMC statements.  The dollar has not changed much on balance.  Long-term interest rates are a little higher.  Share prices have risen, and oil prices are somewhat lower.  None of these moves has been substantial.

  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 1.4665 82.63 3.36 12612 112.48
06/22/11 1.4392 80.12 2.97 12175 94.87
08/09/11 1.4234 77.09 2.36 10993 81.76
09/21/11 1.3778 76.34 1.93 11377 86.74
11/02/11 1.3724 78.11 2.03 11805 92.77
12/13/11 1.3067 77.92 1.98 12130 100.20
01/25/12 1.2966 78.27 2.06 12595 97.85

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

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