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FOMC: Positioning for rate cuts

Wed, Oct 8 2008, 07:43 GMT
by Peter Possing Andersen, Signe Roed-Frederiksen

Danske Bank A/S

Overview: Last night the Minutes of the FOMC meeting on 16 September were published following shortly after a speech in Washington by Fed. Chairman Bernanke on the economic outlook and financial markets. While the Minutes mostly contained old news, Bernanke’s speech suggested that the level of concern about the growth outlook has intensified since the meeting and that the Fed is now on an easing bias.

Details: The Minutes suggest that the outlook was marked down slightly at the 16 September meeting as incoming data had weakened and financial market stress worsened. At that point the committee forecast that the economy would continue to expand, albeit very slowly through year-end before gradually regaining traction during 2009. Members expressed more confidence regarding the prospects of inflationary pres-sure beginning to ease over the coming year. As was apparent from the statement, the balance of risk was very neutral and further rate cuts were not on the table at the meeting. However, some members noted that ‘if intensifying financial strains led to a significant worsening of the growth outlook, a policy re-sponse could be required’.

In yesterday’s speech Bernanke outlined the recent dramatic events in financial markets and the ensuing measures taken by the Treasury and Fed. The Chairman made it clear that financial conditions have dete-riorated significantly lately – particularly due to mounting pressure in the money market – and concluded that ‘developments in financial markets pose a significant threat to economic growth’. The passage on growth indicated that the Board has been marking down its growth path further compared to the one pre-sented at the 16 September meeting. The overall assessment in the speech suggests that the central bank is now moving toward an easing bias noting that ´the combination of the incoming data and recent fi-nancial developments suggests that the outlook for economic growth has worsened and that the down-side risks to growth have increased. At the same time, the outlook for inflation has improved somewhat, though it remains uncertain. In light of these developments, the Federal Reserve will need to consider whether the current stance of policy remains appropriate.’

Assessment & Outlook: Following developments which have occurred during the past 3-4 weeks down-side risks to growth have increased. Firstly, the financial crisis has intensified significantly with the money market coming under extreme pressure and stock markets plunging to 2003 levels. Secondly, incoming data suggest that the current state of the economy is weaker than anticipated only a few weeks ago. As a result, pressure on the Fed to ease its monetary policy further has intensified significantly. Consequently, we are changing our macro and Fed forecasts. We now expect a 50bp rate cut to 1.50% at the October meeting and a final 25bp rate cut to 1.25% at the December meeting. However, if financial markets fail to stabilise shortly we cannot rule out the possibility that the Fed will move much sooner. Later this week we will publish details of our revised macroeconomic forecast.

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Published on  Wed, Oct 8 2008, 07:46 GMT