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Sunday, June 19, 2011

FOMC Meeting Preview

by Calculated Risk on 6/19/2011 12:15:00 PM

There will be a two day meeting of the Federal Open Market Committee (FOMC) this coming Tuesday and Wednesday. I expect no changes to the Fed Funds rate, or to the program to reinvest principal payments, or to the Large Scale Asset Purchase program that is scheduled to end this month (LSAP, aka "QE2"). Basically the Fed is on hold.

Jon Hilsenrath at the WSJ summed it up last week: No Fed Shift Seen at June Gathering

Fed officials are neither looking to tighten nor to ease monetary policy as they prepare for the meeting June 21 and 22 of the Federal Open Market Committee, the Fed's decision-making body.

With job gains potentially slowing, housing prices sliding and consumers spending cautiously, officials don't want to tighten financial conditions. This means they will maintain short-term interest rates near zero and keep the central bank's $2.6 trillion of securities holdings from shrinking. At the same time, because inflation has picked up, they're reluctant to embrace new initiatives aimed at boosting growth.
On Friday, Goldman Sachs economist Sven Jari Stehn argued that there is a large "zone of inaction" for the Fed, and it would take a large surprise (much slower economy or much higher inflation) to get the Fed to take action. From Stehn:
"Our analysis ... suggests that larger surprises than those seen in recent weeks are needed for the FOMC to move out of its zone of inaction. We conclude that the ... weakness in growth and uncertainty about the effect of temporary factors will keep policy and, most likely, policy communication unchanged for the foreseeable future.

The implication of this analysis for next week’s FOMC press conference is that Chairman Bernanke is likely to stay far away from indicating any changes in the policy stance. Most likely, he will be “balanced” by emphasizing both the disappointment in the activity indicators and the higher inflation data. So the press conference is unlikely to be pleasant for either the chairman or his audience."
Concerning the recent slowdown - it is difficult to distinguish between temporary factors or something worse - so the Fed will probably remain on hold until the situation is more clear. The temporary factors include the supply chain issues related to the tragic events in Japan, the sharp increase in oil and gasoline prices partially attributable to events in the Middle East and North Africa, and possibly the severe weather in the U.S.

Remember, in early April Bernanke said:
"I think the increase in inflation will be transitory," ... He attributed the strong gain in global energy and food prices to supply and demand conditions, adding he reckons these prices "will eventually stabilize."
Since then oil and gasoline prices have fallen sharply, but core inflation has ticked up a little.

Some things to look for:

1) Fed Chairman Press Briefing. This is the second of the new press briefings. The FOMC statement will be released earlier than usual - around 12:30 PM ET on Wednesday, and the Chairman's press briefing will be held at 2:15 PM.

At the press briefing, Chairman Bernanke is expected to discuss the new FOMC forecasts (these forecasts used to be released a few weeks after the FOMC meeting with the minutes). Growth forecasts have probably been revised down since April, the unemployment rate revised up, and inflation forecasts might have been revised up.

Here are the updated forecasts through April. The FOMC GDP forecasts for 2011 were revised down in April, and will probably be revised down again in June.

GDP projections of Federal Reserve Governors and Reserve Bank presidents
Change in Real GDP1201120122013
Jan 2011 Projections3.4 to 3.93.5 to 4.43.7 to 4.6
April 2011 Projections3.1 to 3.33.5 to 4.23.5 to 4.3
June 2011 Projections?????????
1 Projections of change in real GDP and in inflation are from the fourth quarter of the previous year to the fourth quarter of the year indicated.

The unemployment rate was revised down in April, but with the uptick in the unemployment rate over the last two months to 9.1%, the unemployment rate for Q4 2011 will probably be revised up this time.

Unemployment projections of Federal Reserve Governors and Reserve Bank presidents
Unemployment Rate2201120122013
Jan 2011 Projections8.8 to 9.07.6 to 8.16.8 to 7.2
April 2011 Projections8.4 to 8.77.6 to 7.96.8 to 7.2
June 2011 Projections?????????
2 Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated.

I suspect inflation will be a key topic at the FOMC meeting. The forecasts for overall and core inflation were revised up in April and will probably be revised up again in June.

Inflation projections of Federal Reserve Governors and Reserve Bank presidents
PCE Inflation1201120122013
Jan 2011 Projections1.3 to 1.71.0 to 1.91.2 to 2.0
April 2011 Projections2.1 to 2.81.2 to 2.01.4 to 2.0
June 2011 Projections?????????

Core Inflation projections of Federal Reserve Governors and Reserve Bank presidents
Core Inflation1201120122013
Jan 2011 Projections1.0 to 1.31.0 to 1.51.2 to 2.0
April 2011 Projections1.3 to 1.61.3 to 1.81.4 to 2.0
June 2011 Projections?????????

2) Possible Statement Changes. I don't expect the key sentence "likely to warrant exceptionally low levels for the federal funds rate for an extended period" to be changed any time soon.

There will probably be some changes to the first paragraph to mention the recent softer economic data and pickup in inflation - however the statement will probably say the increase in inflation is expected to be transitory. I expect the phrase "the economic recovery is proceeding at a moderate pace" to be downgraded a little. And the word subdued might be changed in the phrase on inflation: "Inflation has picked up in recent months, but longer-term inflation expectations have remained stable and measures of underlying inflation are still subdued."

3) Timeline for the Fed. Remember all those "analysts" saying QE2 would end early and predicting the Fed would raise rates this year? Wrong again ...

QE2 will end in June as scheduled. It also appears the Fed will continue to reinvest maturing securities - at least for a couple of months following the end of QE2 (the next meeting is in August). This means the Fed's balance sheet will remain stable following the completion of QE2 - until the economy weakens further or the pace of growth picks up.

The next step for the Fed - after the end of QE2 - will be to either: 1) end the reinvestment (if economic growth improves), or 2) launch QE3 (if the economy weakens). I don't think either action is likely in the near term.

And this means the Fed will not raise rates for, well, an "extended period". If they do end reinvestment in the next few months, they will probably wait even longer to drop the "extended period" language, and then a couple more meetings (at least) before they raise rates.

Summary for Week Ending June 17th
Schedule for Week of June 19th