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FOMC minutes: Still cautious

Thu, Oct 15 2009, 12:24 GMT
by Peter Possing Andersen, Signe Roed-Frederiksen

Danske Bank A/S

• Growth expectations were raised but there were few changes to the inflation outlook
• Labour market conditions were expected to improve only slowly and consumer spending to be no more than moderate
• Uncertainty over just how much slack exists justifies careful monitoring of longer-term inflation expectations and the clear communication of exit strategies
• Surprisingly, some members favoured an expansion of the MBS purchase program while only one wished to reduce it
• The outlook is unchanged with the Fed leaving rates close to zero for a very long time

Details: FOMC minutes generally reflected less disunity than might have been expected following the wide range of opinions expressed by individual committee members in recent weeks. The most surprising fact was that several members favoured expanding the MBS purchase program while only one wanted to scale it down.

Generally the minutes showed that both the staff and committee had raised their growth expectations especially for the near term. The staff forecast growth in 2010 at slightly above its estimate of potential on a Q4/Q4 basis implying a decline in unemployment to around 9.25% by end 2010. GDP growth is projected to be more substantially above trend in 2011, driving the unemployment rate down to 8% by the end of that year.

Despite upgraded growth expectations, FOMC members still believe the economic recovery will be “quite restrained” and foresee only a gradual decline in the unemployment rate in 2010. Businesses are expected to be reluctant to hire while loss of skills and a greater need for labour reallocation could further slow employment growth.

Most participants therefore expected the slack in both labour and product markets to be “substantial over the next few years, leading to subdued and potentially declining wage and price inflation”. The risks to inflation were largely balanced in the eyes of many participants with some seeing a risk of further disinflation in the near term although "a few" identified upside risks over a "longer horizon."

Some members were concerned that the Fed’s large balance sheet would risk un-anchoring inflation expectations and all agreed that longer-term inflation expectations should be watched carefully. Furthermore, the Fed should communicate clearly its ability and willingness to withdraw policy accommodation in order to anchor inflation expectations. Consequently, the minutes show that talk of exit strategies does not necessarily imply rate hikes in the near future. Rather, such statements keep longer-term inflation expectations in check. The Fed seems to be pursuing a ‘better-safe-than-sorry’ approach with nothing in the minutes suggesting any near-term changes in its policy stance.

Assessment and outlook: We continue to expect the Fed to leave rates unchanged for a long time, with hikes not earlier than Q4 next year. Slack in the US economy will remain substantial compared to historical levels and for a long period. This implies a non-negligible risk of core inflation reaching zero next year, which in turn would make the Fed even more wary of hiking rates. Further, the Fed will probably spend some time assessing the impact on mortgage markets of ending its purchases before beginning to consider rate hikes.

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Published on  Thu, Oct 15 2009, 12:27 GMT