Highlights of the Minutes of June 23-24 FOMC Meeting and View about Quantitative Easing
New economic projections indicate that the Fed sees economic activity declining in 2009 but at a less rapid pace than what was expected in April (see table 1). The unemployment rate is now projected to be higher than the April prediction and will hold at an elevated level well into 2011 (see table 1). Forecasts of overall and core inflation have been raised slightly compared with the April forecast.
More importantly, the Fed’s view about quantitative easing was included in the minutes. The minutes indicate that the Fed has no plans to change the size of the existing programs in the near term.
With regard to mortgage securities, here is the Fed’s view: “The Federal Reserve was already purchasing a very large fraction of new current-coupon agency MBS and agency debt, and further increasing the scale of those programs could compromise market functioning.”
The opinion about Treasury securities is seen here: “Some participants thought that increases in purchases of Treasury securities might have little or no effect on long-term interest rates unless the increases were very sizable, given the large amount of current and projected supply of Treasury securities. Others were concerned that announcements of substantial additional purchases could add to perceptions that the federal debt was being monetized. While most members did not see large-scale purchases of Treasury securities as likely to be a source of inflation pressures given the weak economic outlook, public concern about monetization could have adverse implications for inflation expectations.”
The Fed’s estimation about the programs and interest rates: “The asset purchase programs were intended to support economic activity by improving market functioning and reducing interest rates on mortgage loans and other long-term credit to households and businesses relative to what they otherwise would have been. But the Committee had not set specific objectives for longer-term interest rates, and participants did not consider it appropriate to allow the Desk discretion to adjust the size and composition of the Federal Reserve's asset purchases in response to short-run fluctuations in market interest rates. Some participants noted that, in principle, the Committee could formulate a plan for asset purchases that would respond to economic and financial developments in a way that might better promote monetary policy objectives. Most, however, thought that formulating and communicating such a plan would be very difficult, potentially leading to an increase in market uncertainty regarding Federal Reserve actions and intentions.”
The Fed essentially extended most programs until February 2010 for the following reasons: A number of the credit and liquidity facilities that the Federal Reserve had established in the course of the financial crisis were scheduled to expire on October 30. Use of most of the liquidity facilities had declined in recent months as market conditions had improved. Still, meeting participants judged that market conditions remained fragile, and that concerns about counterparty credit risk and access to liquidity, both of which had ebbed notably in recent months, could increase again. Moreover, participants viewed the availability of the liquidity facilities as a factor that had contributed to the reduction in financial strains. If the Federal Reserve's backup liquidity facilities were terminated prematurely, such developments might put renewed pressure on some financial institutions and markets and tighten credit conditions for businesses and households. The period over year-end was seen as posing heightened risks given the usual pressures in financial markets at that time. In these circumstances, participants agreed that most facilities should be extended into early next year. However, participants also judged that improved market conditions and declining use of the facilities warranted scaling back, suspending, or tightening access to several programs, including the Term Auction Facility (TAF), the Term Securities Lending Facility (TSLF), and the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF).
Following the presentation and discussion of the staff proposal, the Board voted unanimously to extend the AMLF, the Commercial Paper Funding Facility (CPFF), the Primary Dealer Credit Facility (PDCF), and the TSLF through February 1, 2010. The Board did not extend the Money Market Investor Funding Facility (MMIFF) beyond October 30. The extension of the TSLF required the approval of the Federal Open Market Committee (FOMC), as that facility was established under the joint authority of the Board and the FOMC. The Board and the FOMC jointly decided to suspend some TSLF auctions and to reduce the size and frequency of others. In addition, the FOMC extended the temporary reciprocal currency arrangements (swap lines) between the Federal Reserve and other central banks to February 1, 2010. The FOMC unanimously passed the following resolution to extend the temporary swap arrangements and the TSLF.
Board members and FOMC participants noted their expectation that a number of these facilities may not need to be extended beyond February 1, 2010, if the recent improvements in market conditions continue. However, if financial stresses do not moderate as expected, the Board and the FOMC were prepared to extend the terms of some or all of the facilities as needed to promote financial stability and economic growth.”
Gasoline Prices Raise Overall CPI, Core CPI Remains Contained
The Consumer Price Index (CPI) rose 0.7% in June vs. a 0.1% increase in the prior month. A sharply higher price for gasoline (+17.3%) is the major culprit accounting for over 80 percent of the increase in the overall CPI. The June CPI is down 1.4% from a year ago and it marks the fourth consecutive monthly decline. In June, the energy price index moved up 7.4% vs. a 0.2% increase in May.
The CPI index excluding energy rose 0.2% in June after a string of 0.1% gains since February. Excluding energy, the CPI increased 1.8% from a year ago, representing a deceleration after the peak reading of a 3.1% gain in August 2008.
Food prices held steady in June, with the underlying trend showing a marked deceleration in late-2008 (see chart 3).
Excluding food and energy, the core CPI rose 0.2% in June following a 0.1% gain in the prior month. In June, higher prices for new cars (+0.5%), used cars (+0.9%), apparel (+0.7%) made up the large price gains contributing to the higher core CPI. Shelter costs increased only 0.1% for the second straight month, reflecting similar gains in the rent and owners’ equivalent sub-components of the shelter index. On a year-to-year basis, the core CPI was up 1.73% in June, which is close to the cycle low of a 1.68% increase posted in January 2009. The main take away is that the core CPI does not show a problematic trend and is most likely to trend lower due to weakness in consumer demand. The main focus of monetary policy is to stimulate economic growth and employment, with concerns about inflation on hold, for now.
The year-to-date numbers present a slightly different picture, with core CPI in the first six months of the year increasing 2.3% vs. a 1.8% gain in all of 2008. The four major categories of the core CPI that have helped to lift the index in the first six months of the year are new cars, tobacco, apparel, and medical care (see charts 5 and 6). Of these four categories, higher tobacco prices is a one-off event reflecting higher taxes, while higher prices for new vehicles is suspect given the significant weakness in demand for cars. The trend of medical care and apparel prices are not transitory factors.
Factory Sector Remains Weak, with Some Moderation in Pace of Decline
Industrial production fell 0.4% in June following a 1.2% decline in May. In the second quarter, industrial production fell 11.7% vs. a 19.1% drop in the prior quarter. Factory production (excludes utilities and mining components) dropped 0.6% in June vs. a 1.1% plunge in May. In the second quarter, factory production was down 10.5% compared with a 22% drop in the first quarter. These data suggest that factory activity is weak but there is a noticeable moderation in the pace of decline (see chart 7).
Machinery, computer and electronic products, electrical equipment, appliances, and components, and motor vehicles and parts all posted decreases of more than 1%, while production of wood products, primary metals, and miscellaneous manufacturing rose. The gain of 1.7% for primary metals follows 10 consecutive monthly decreases. Output of the auto sector should increase as Chrysler and GM resume operations after bankruptcy proceedings.
The rate of capacity utilization for the total industry fell in June to 68.0% percent, a historical low. The previous low was 70.9% in December 1982. The operating rate of the factory sector dropped in June to a historical low of 64.6%; prior to the current recession, the low for this series, which begins in 1948, was 68.6% in December 1982. The enormous slack in the factory sector supports expectations of contained inflation in the near term.
