Federal Open Market Committee Meeting Concludes – Meeting Expectations

The Federal Open Market Committee (FOMC) concluded its June meeting. The standard summary statement, Chairwoman Yellen’s press conference, and the economic projections of the meeting participants contained no real surprises.

The statement expressed the committee’s confidence that economic activity is rebounding and the labor market is improving, although the unemployment rate remains elevated. The pace of asset purchases will be reduced by another $10 billion increment, to $35 billion per month, based on this continuing progress, with similar future reductions predicated on the economic recovery meeting expectations. The federal funds rate will remain at the current level for a “considerable time” after the end of asset purchases.

The economic projections of GDP growth in 2014 were reduced sharply compared to the projections at the March meeting, but growth was maintained in 2015 and 2016. Chairwoman Yellen explained at her press conference that this was basically incorporating the contraction of the first quarter rather than a loss of confidence in future growth. The projections of the unemployment rate were modestly lower while inflation projections were largely unchanged.

At the press conference Chairwoman Yellen emphasized that the first quarter contraction was based on transitory factors and early indications suggest that the economy is rebounding in the second quarter but underutilization in the labor market continues to be an issue of concern. Overall the committee remains confident enough in the outlook to continue reducing the asset purchase program.

Chairwoman Yellen also used the press conference to stress that the Fed’s policy stance has been and would continue to be data driven. The pace of asset purchase reductions and the timing and duration of increases to the federal funds rate are conditional on continuing improvement in the economic recovery. Neither of these policy tools is on a preset course.

Overall, the results of the meeting met expectations.

 

Timing The First Move – Honest, We Were Just Talking

With expectations of the pace of retreat from longer term interest rates firmly grounded, attention has turned to the timing of the first move to raise short term interest rates. Some insights into the timing and process were made available in the minutes from the April 29-30 Federal Open Market Committee (FOMC) meeting released by the Federal Reserve.

To avoid the adverse reaction (100 basis point jump in longer term interest rates) experienced last spring when the Fed outlined what the process of winding down its asset purchase program (QE3) might look like, the minutes included the phrases “eventual normalization,” “prudent planning and did not imply that normalization would begin sometime soon,” and “raising short-term interest rates when it becomes appropriate to do so” in the first three sentences to communicate that the discussion was planning for the future.

A presentation included the technical details of a range of policy tools and approaches. The discussion ended with “Participants generally agreed that starting to consider the options for normalization at this meeting was prudent, as it would help the Committee … to communicate its plans to the public well before the first steps in normalizing policy become appropriate.”

In business other than agreeing that the first move for the fed funds rate won’t come until “a considerable time after the asset purchase program ends” (our guess is June 2015), the committee agreed that the economic outlook is generally positive, with the first quarter slowdown weather related and indications that the economy is already bouncing back, although downside risks persist.

The committee agreed that the economic outlook was little changed since the March meeting, with growth strengthening through 2014 and 2015. But the clearest message from the minutes is that for all the talk, short term interest rates are going nowhere fast.

 

GDP Growth and the Fed’s Perspective – Riding the Storm Out

The Bureau of Economic Analysis (BEA) released the advance estimate of real GDP growth for the first quarter of 2014. Real GDP grew at a 0.1% seasonally adjusted annual rate, a sharper slowdown from the 2.6% growth in the fourth quarter than we expected. The slowdown was broad based, with every major category subtracting from growth except personal consumption expenditures (PCE). PCE grew at a respectable 3.0% seasonally adjusted annual rate, but was still slower than the 3.3% rate last quarter.

The biggest drags on growth were from exports and investment. The slowdown in investment was expected based on an anticipated pullback in inventory investment, but severe winter weather was a surprise that constrained fixed investment in equipment and homebuilding.

The good news is that the drag from investment will turn into a positive as fixed investment rebounds from the bad weather, particularly homebuilding, and the effects of inventory rebalancing wane. We expect growth to bounce back in the second quarter and gain strength through the rest of the year.

This view of optimism going forward is shared by the Federal Reserve’s monetary policy arm, the Federal Open Market Committee (FOMC). In the statement released today following their two day meeting the committee characterized growth in economic activity as having picked up since the March meeting, following the adverse weather conditions.

But beyond the language of the statement, a more significant indicator of the FOMC’s confidence that the economy will strengthen was the decision to continue on course with the reduction to the Fed’s asset purchasing program. By announcing a further $10 billion reduction in monthly asset purchases the committee is signaling its belief that the economic recovery is proceeding consistent with their expectations based on the underlying strength of the fundamentals and that the weakness in first quarter growth was due to temporary factors.

Fed Policy, Then and Now

Last week the Federal Reserve released the minutes from the most recent Federal Open Market Committee (FOMC) meeting (January 28-29), as well as transcripts from the meetings held in calendar 2008. (Minutes are released 3 weeks after the conclusion of the meetings, transcripts are released for the entire year with a five year lag.) These accounts represent the bookends of Fed policy from the beginning of the financial crisis to the evolution of that policy to date.

The transcripts from the 2008 meetings provide a detailed look at the deliberations surrounding the critical events of the crisis: the rescue of Bear Stearns, the bankruptcy of Lehman Brothers, the American International Group (AIG) bailout, as well as the beginning of the series of extraordinary lending and credit facilities used by the Fed to keep the US and global financial system functioning (2008 transcripts).

The decision to let Lehman Brothers fail has been the subject of criticism, defenses and memoirs among the primary figures of global finance at the time. The transcripts present the perspectives of FOMC members as event unfolded.

The minutes from the January meeting offer a view of the discussions among FOMC members regarding the winding down of the two currently most prominent policy tools: the federal funds rate and the third incarnation of quantitative easing (January minutes).

The key points from the January meeting include: that economic growth and the labor market are continuing to recover; this allows for a continuation of the measured reductions in the asset purchase program; and, with the 6.5% unemployment rate threshold nearly reached, a change in forward guidance to effectively communicate the anticipated path for the federal funds rate is necessary.

The most appropriate information to include in the forward guidance remains the subject of debate, ranging from a new quantitative target to additional language characterizing the health of financial markets. These differences regarding forward guidance were in contrast to reductions in asset purchases, where the broad consensus was for modest reductions at each meeting, absent any significant change in economic conditions.

With the dust settled from the height of the crisis, the consensus among economists is that overall Fed policy prevented a more severe economic downturn. The impact and timing of individual decisions will continue to be debated, but the end result was unambiguously positive for the economy.

 

Federal Open Market Committee Meeting Concludes – The Song Remains The Same

The Federal Open Market Committee (FOMC) concluded its January meeting, the last meeting with Ben Bernanke as chairmen, and Janet Yellen confirmed as the incoming chairwomen. The change in leadership is expected to have no impact on monetary policy. Bernanke and Yellen have been of one mind throughout the Fed’s extraordinary stimulus program.

The statement released to the public following the meeting informed that the tapering of asset purchases would continue. The Fed will reduce purchases from the January pace of $75 billion per month to $65 billion in February, and following the pattern of the December announcement, the reduction will be evenly split between Treasury securities and mortgage-backed securities (MBS). Beginning in February asset purchases will be $35 billion of longer-term Treasury securities and $30 billion of MBS.

The continuation of the tapering was based on a modestly upgraded assessment of economic growth and the labor market, despite the weak December payroll employment numbers reported in early January. The Fed made no change to its forward guidance, maintaining that the federal funds rate would remain at the current low level until well past the point when the unemployment rate fell to or below 6.5%, conditional on a benign inflation environment. Some analysts expected the Fed might lower the unemployment rate threshold, but no change was made and additional reliance on other labor market indicators was reiterated.

The impact on interest rates in the wake of the tapering has been subdued. The interest rate on 10-year Treasury securities has been declining in January based on concerns about overseas economies, rather than rising based on Fed actions. The interest rate on 30-year fixed rate mortgages has been following the 10-year down.

 

Federal Open Market Committee Meeting Minutes – A Look Inside The Process

The minutes from the December meeting of the Federal Open Market Committee (FOMC) were released and offer a closer look at the deliberations of the Federal Reserve’s monetary policy setting arm. Chairman Ben Bernanke provided a thorough summary of the key decisions and issues in his press conference that followed the December 17-18 meeting (Federal Open Market Committee Meeting Concludes – The Beginning of the End). The committee’s view is that the economic recovery is gaining strength and the outlook going forward is encouraging enough to begin winding down the bond buying program that began in September 2012. The pace of the reductions will be gradual, driven by incoming economic data, and not by a pre-determined schedule. The federal funds target rate will remain at its current low level at least until the unemployment rate falls below 6.5%, and in all likelihood for a considerable period after that threshold is reached. In addition to labor market conditions, the committee will be closely monitoring inflation, which has been below the target rate of 2%, posing a risk to economic growth and potentially signaling a recovery that is weaker than some other indicators suggest.

The minutes provide a more nuanced view of the internal debates than is available from the vote counts supporting or opposing the actions of the committee. The decision to reduce asset purchases had both supporters and opponents, and among the supporters, views on the appropriate pace of reductions differed. Lowering the unemployment rate threshold was debated, as was the role of inflation below the target level as a consideration in adjusting the federal funds target rate.

The committee’s views on the housing sector were encouraging. Despite a slowdown in activity in recent months in response to rising interest rates, expectations were that the housing recovery would continue. A still favorable interest rate environment combined with rising home values, improving employment, incomes and confidence were identified as factors that would continue to support housing demand.

The summary of economic projections released with the minutes expanded on the material released immediately after the December meeting. The materials include meeting participants’ expectations of the level of the federal funds target rate at year end for the years 2013-2016. Most participants expect the first increase to come in 2015, with the funds rate still at or below 1% at the end of 2015, and at or below 2% at the end of 2016. This is consistent with the NAHB forecast of favorable mortgage interest rates supporting continued housing demand throughout the 2014-2015 forecast.

 

Federal Open Market Committee Meeting Concludes – The Beginning of the End

The Federal Open Market Committee (FOMC) concluded its December meeting and announced that it would begin the much anticipated winding down of its asset purchase program, popularly referred to as tapering QE3. The Fed will reduce purchases from the current $85 billion per month to $75 billon, with the reduction evenly split between Treasury securities and mortgage-backed securities (MBS). Beginning in January asset purchases will be $40 billion of Treasury securities and $35 billion of MBS.

At his press conference following the two day meeting Chairman Bernanke reiterated and expanded on the statement released to the press, noting that further reductions in the pace of asset purchases were likely at subsequent meetings, as long as the incoming economic data continued to show improving strength. He emphasized, once again, that the path of asset purchases was not pre-determined, that it would be data driven, and that future developments could motivate further declines or a pause in the pace of reductions. In response to questions Bernanke accepted the possibility that asset purchases could even re-accelerate if the economy stumbled at some point in the future. But he also emphasized that the Fed has a range of tools beyond asset purchases, including forward guidance and the interest rate on bank reserves held at the Fed to provide appropriate monetary stimulus in support of the recovery.

Based on the consensus of the forecasts prepared by meeting participants the gradual winding down of asset purchases would conclude the program sometime in the second half of 2014.

Bernanke also emphasized that the end of the asset purchases should not distract from the fact that monetary policy would still be highly accommodative with the Fed funds rate remaining at its current 0-.25 percent range at least as long at the unemployment rate was above 6.5 percent, and in all likelihood well past this point, as the committee monitors a range of other labor market indicators. Twelve of the 17 meeting participants anticipated that the first increase in the Fed funds rate would come in 2015. With these increases 12 participants expected the Fed funds rate to remain at or below 1 percent by the end of 2015, and 10 participants expected the Fed funds rate to be at or below 2 percent by the end of 2016. Over the longer term meeting participants viewed the appropriate level for the Fed funds rate to be between 3.50 and 4.25 percent.

Inflation, the other half of the Fed’s dual mandate, entered the discussion with Bernanke noting that the Fed’s charge was to keep inflation from getting too low, as well as too high. Bernanke shared that discussion among committee members included the possibility of an inflation floor as a policy guide, but the committee deemed it not necessary at this point. The expectation among participants was that inflation would gradually rise toward the target 2 percent over the next several years.

The stock markets responded positively, jumping at the 2:00 pm release of the Fed statement to the press and rose throughout the day on the Fed’s endorsement that the economic recovery was gaining strength and sustainable.

 

October Federal Open Market Committee Meeting Concludes – Waiting For Good Data

The Federal Open Market Committee (FOMC) concluded its October meeting and announced that it would continue the asset purchase program at the current $85 billion per month pace. The committee repeated its consistent message that the purchases would continue until incoming data indicated substantial and sustained improvement in the labor market. The waiting is likely to continue for at least a few more months as analysts try to separate signals from the noise introduced by the early October federal government shutdown.

The October report on September labor market conditions was released two weeks late due to the shutdown and showed payroll growth slowing even before the shutdown took place. The report on October conditions will be delayed one week later in early November and is expected to be tainted by weak growth reflecting a private sector response to the shutdown (furloughed government employees are treated as employed). The weak October conditions will be followed by an overly strong surge in employment as private sector government contractors and employees in support businesses return to work for the full month of November. The report will be released on time in early December, but the January report on December conditions will be the first report free of shutdown distortions.

These distortions in labor market conditions will be mirrored in the range of indicators that policymakers rely on to guage the strength of the economy, including GDP growth, inflation, and the housing sector. This level of contamination in the data has some analysts pushing their predictions of any scaling back or tapering of the Fed’s asset purchases into next year.

For readers of FOMC policy tea leaves two aspects in today’s statement are of interest. First, while the committee’s assessment of the broad economy was largely unchanged since the September meeting, the characterization of the housing sector changed. In September the housing sector was strengthening but mortgage rates were rising. In October the housing sector slowed somewhat in recent months with no reference to mortgage rates.

Second, not only was the mortgage rate language removed from the characterization of the housing market, September’s reference to the tightening of financial conditions (meaning rising longer term interest rates) as a threat to a faster pace of improvement in economic growth and the labor market was dropped.

These changes in the wording of the statement may signal the FOMC has new anxiety about the housing sector, one of the relative (still not fully recovered) bright spots in the economy, but also that the committee feels it has effectively “talked down” interest rates by defying expectations and not tapering in September. The interest rates on 10-year Treasury securities and 30-year fixed rate mortgages have dropped by 40-50 basis points since the mid-September FOMC meeting.

The decline in interest rates should assuage concerns about housing, so perhaps the mixed signals are the FOMC shifting the blame for a slowing housing market from rising interest rates to “crisis governing.” Fiscal policy restraining growth has been a recurring theme at recent FOMC meetings and the methods of restraining growth have grown increasingly dire. Sequestration, the shutdown, yet another near miss on the debt ceiling, these have trimmed economic growth directly through cutbacks and indirectly by rattling consumer and business confidence.

For now it looks like the timing of any tapering is in limbo. The FOMC repeated today that the decision will be data driven, but it will be some months before the data is telling the truth (and the committee probably knows that). And part of the decision not to taper in September was queasiness with the fiscal policymaking process. Given that the federal budget and the debt ceiling (and revisiting sequestration) decisions have been postponed until January and February rather than decided, the queasiness probably shouldn’t subside.

One scenario is theoretically possible. Suppose the October and November labor market data, as well as other economic indicators, are stronger and less shutdown affected than is expected (unlikely), and the warring factions in Washington make peace and fiscal policy in a way that avoids another early 2014 nail-biter (highly unlikely). Under these conditions the FOMC could declare “the improvement in economic activity and labor market conditions since it began its asset purchase program as consistent with growing underlying strength in the broader economy” and announce tapering in December. Or maybe they’ll wait until March.

 

Federal Open Market Committee Meeting Concludes – No News Is Good News (For Mortgage Rates)

The Federal Open Market Committee (FOMC) concluded its September meeting and announced that it would continue the asset purchase program (popularly referred to as QE3) at the current $85 billion per month pace. Most analysts were expecting the announcement to be of a reduction in bond purchases (popularly referred to as tapering).

The published statement and Chairman Bernanke’s press conference following the meeting explained that the decision to continue purchases at the current level was based on the unevenness of the labor market improvement combined with the threat to continued improvement posed by renewed fiscal policy drama, and the recent tightening of financial conditions. The fiscal policy drama refers to the looming political battles over a federal budget for the upcoming fiscal year (beginning October 1) and raising the debt ceiling (due to be necessary by mid-October). The tightening of financial conditions is the sharp increase in longer-term treasury securities and 30-year fixed mortgage rates (100+ basis points) since May when the Fed first broached the subject of tapering.

Bernanke got some of what he wanted. The interest rate on 10-year treasury securities dropped at 2 pm when the statement was released and closed at 2.69%, 16 basis points below yesterday’s close. This won’t totally reverse the rate increases but it should at least push the pause button on what has been the markets’ overreaction to the mere mentioning of ending QE3. And this respite should pass through to longer-term mortgage rates.

Avoiding a government shutdown or debt default will be up to Congress and the Obama administration, but Bernanke’s message today was clear: monetary policy support for a struggling economic recovery will remain in place for the time being.

 

GDP and FOMC – Two Reports, One Big Surprise

The Bureau of Economic Analysis (BEA) released the advance estimate of real GDP growth for the second quarter of 2013 and the Federal Open Market Committee (FOMC) concluded its two day meeting with the release of the traditional statement reporting on the committee’s actions. These two reports have been much anticipated as analysts track the pace of the economic recovery and consider the Fed’s reaction to it. The irony has been that a weak economy (bad news) pushes the Fed toward further accommodation (a desirable outcome) while a stronger economy (good news) pushes the Fed to begin winding down asset purchases, reducing accommodation (a less desirable outcome).

Today’s reports surprised more on the GDP news than on the FOMC news.

Real GDP grew at an annual rate of 1.7% in the second quarter, well above earlier expectations of a sharp slowdown following the 1.8% growth rate in the first quarter (prior to revisions). But comprehensive revisions, which the BEA completes generally every five years, revised first quarter growth down to 1.1% (in addition to a host of other updates, see Revisions). So not only didn’t growth slowdown sharply, it accelerated between the first and second quarters. Beyond these two quarters the revisions largely preserved the uneven pattern of recent growth, but lowered growth modestly in the last 3 quarters and raised it in the preceding 4 quarters. Overall, the revisions raised average real GDP growth since the end of the Great Recession (June 2009) to 2.2% from 2.1%.

The FOMC confirmed expectations, announcing no major policy shift following its meeting. Asset purchases (QE3) will continue for the time being and any increase in the target for the federal funds rate is still contingent on the unemployment rate dropping to or below 6.5%, with the standard caveat about inflation and inflation expectations.

Few expected a change in monetary policy at this meeting, the real wagering is about at what point later this year (or even next) the Fed will begin to wind down its asset purchases (the “tapering”). A June survey of economists showed expectations fairly evenly distributed across the final 3 FOMC meetings of the year in September, October and December.

The language in today’s statement included some tweaks suggesting a Fed more anxious about the economy than anxious to reduce accommodation. According to this morning’s GDP report, economic growth was slower in recent quarters than originally estimated and the FOMC statement downgraded the language to reflect the committee’s expectation that growth “will pick up from its recent pace” rather than “proceed at a moderate pace” following the June meeting.

The FOMC also acknowledged the recent increase in mortgage rates as a potential threat to a strengthening housing sector, as well as more aggressively referring to persistent inflation below the 2% target as a risk to the economy. These changes in the statement suggest that any change to the timing of tapering would be to push it back rather than pull it forward.

Today’s reports have done little to clarify the likely path of the economy in the near term. GDP growth accelerated rather than decelerated in the second quarter. Are we gaining momentum or is there a much anticipated sequestration-slowdown looming in the second half of the year? (Could we have dodged that bullet completely?) If the Federal Reserve is any indicator, anxiety about the economy seems to be getting higher not lower. Fed chairman Bernanke has emphasized repeatedly that monetary policy will be driven by the economic data. So far, that’s not helping.