Stone McCarthy Analysis of Fed Statement:
FOMC Statement from Oct. 28-29: Keeps ‘’Considerable Time’’
For more information, please contact Terry Sheehan.
—Stone & McCarthy (Princeton)—
Key Take-Aways:
1. The FOMC retained the ‘considerable time’ language for its forward guidance, but overall more hawkish in tone regarding labor market and economy.
2. ‘Underutilization of labor resources is gradually diminishing’.
3. ‘Inflation in the near term will likely be held down by lower energy prices and other factors’.
4. Asset purchases cut by $15 billion; program ends in November.
The FOMC meeting statement of October 29 reflected a stronger assessment of labor market conditions, enough that it satisfied two voters who previously dissented in relation to insufficiently acknowledging the progress made by the economy and labor market. We found the tone of the statement to be substantially more upbeat that the prior version, even with the more cautious wording regarding inflation.
Our read it that this statement is a step in the direction of changing the “considerable time” language in the forward guidance to something that points to a narrowing of the expected interval before the first increase in the fed funds rate target from the 0%-0.25% in place since December 2008. We now expect that that alteration is more probable for the statement after the December 16-17 meeting.
The Committee remains data-dependent in its outlook. The statement said, “To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress—both realized and expected—toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.”
However, the update to the economic assessment acknowledged that the labor market has indeed improved substantially, and “that underutilization of labor resources is gradually diminishing”. It continued, “The Committee judges that there has been a substantial improvement in the outlook for the labor market since the inception of its current asset purchase program”.
The improvement was not enough to cause the Committee to change the forward guidance. The statement said, “The Committee anticipates, based on its current assessment, that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program this month, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored”. Thus, the gains for the labor market have as yet not offset the concerns about too-low inflation.
Our outlook remains for the first hike in the fed funds rate around mid-2015.
In the context of the end of the open-ended asset purchase program, we view this statement as the start of the transition back to more normal monetary policy. However, beyond ending the asset purchases with a final $15 billion cut effective in November, we see no immediate steps to remove any accommodation. The current enormous balance sheet “should help maintain accommodative financial conditions”. The maintenance of the “existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction” will mean the balance sheet will not begin to shrink.
As noted above, two dissenting votes were not repeated. Neither Philadelphia’s Charles Plosser or Dallas’ Richard Fisher cast a “no” vote this time around. This suggested that the statement is now in closer alignment with their respective views regarding progress in the labor market and the expectations for removal of policy accommodation.
However, the vote was 9-1. Minneapolis Fed President Narayana Kocherlakota dissented “in light of continued sluggishness in the inflation outlook and the recent slide in market-based measures of longer-term inflation expectations, the Committee should commit to keeping the current target range for the federal funds rate at least until the one-to-two-year ahead inflation outlook has returned to 2 percent and should continue the asset purchase program at its current level”.
This points to an evolution in the views on the FOMC, with a less dovish outlook for policy for the Committee as a whole. The shift is small, and does not indicate any great hurry on the part of the FOMC to begin the process of policy normalization, but it does indicate a shift in the balance of opinions more toward a moderate center.
