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Fed Policy Statement Is Marginally Dovish

Tue, Aug 5 2008, 22:58 GMT
by Asha Bangalore

Northern Trust

Fed Policy Statement Is Marginally Dovish

The Fed left the federal funds rate unchanged at 2.00%, no surprises here. President Fisher dissented; he would have preferred a higher federal funds rate. The committee included one new member, Governor Elizabeth Duke, who voted in favor of holding the federal funds rate unchanged.

The Fed retained most of the June 25 statement but rearranged the order of sentences and made subtle but important changes. First, the phrase “downside risks to economic growth remain but they appear to have diminished somewhat” is missing. Also, in place of economic activity continues to expand,” the latest statement notes that economic activity expanded in the second quarter.” These changes with regard to growth suggest that the FOMC is less optimistic about economic growth. Second, the more hawkish part of the June 25 statement – “the upside risks to inflation and inflation expectations have increased” is eliminated entirely. The recent reduction in energy and commodity prices is captured by the phrase “earlier increases in prices of energy and some other commodities” as opposed to “continued increases in prices of energy and some other commodities,” which suggest that the FOMC views recent downward movements in energy prices as meaningful.

August 5, 2008:
“Inflation has been high, spurred by earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

June 25, 2008:
“The Committee expects inflation to moderate later this year and next year. However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high.”

The final paragraph, which includes the bias of the FOMC in the intermeeting period, is indicative of the marginally more dovish stance of the Fed compared with the June 25 statement.

August 5, 2008:
“Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee.”

June 25, 2008:
“Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased.”

Inflation expectations, as measure by the difference between the 10-year nominal U.S Treasury note yield less 10-year TIP rate was 2.34% as of August 4, down from 2.57% on July 3, supportive of the Fed’s view about inflation.

In conclusion, hints about a possibility of higher federal funds rate in the near term were absent. The Fed is on hold for several months until financial and housing market stability is visible, employment conditions improve, and consumer spending is on firmer footing.

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Published on  Tue, Aug 5 2008, 23:03 GMT