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FOMC: preview of policy meeting

Mon, Nov 2 2009, 17:10 GMT
by Signe Roed-Frederiksen

Danske Bank A/S

• We expect the FOMC to keep the Fed funds rate unchanged at this week’s meeting. Some media reports have suggested a change to the “extended period” phrasing in the FOMC statement. We believe it is too early for such substantial changes in the wording, which would send yields significantly higher. 
• Economic indicators have been more mixed lately and should not prompt any changes to the assessment of growth. The recent run-up in energy prices is likely to be pointed out as both a risk to growth and inflation. 
• The bias moved more toward neutral at the September meeting and another step in that direction cannot be ruled out. However, the FOMC is expected to proceed cautiously and we expect any changes to be minor and market reaction muted.

Activity: Since the latest FOMC rate decision on September 23 economic data have been mixed. The September employment report showed that job losses continued at an equally rapid pace, the Conference Board’s employment indices were weak and consumer confidence indicators have declined. On the other hand, jobless claims data have shown improvement and job losses are likely to have moderated in October. Consumer spending is currently on a boom-bust path due to auto sales but stripping out the most volatile parts, underlying consumer spending has improved. Housing market indicators have been more mixed, but durable goods orders has been solid, suggesting that investments will provide a boost to activity in coming months. We continue to expect solid growth of around 4% q/q AR in the coming two quarters. On balance, we expect the FOMC statement to leave the assessment of economic activity unchanged.

Inflation: Core inflation is trending down, with core PCE now below the Fed’s comfort zone, and is expected to continue to do so for many months to come. Wage inflation has moderated significantly and an unemployment rate well above the NAIRU (even taking into consideration the uncertainty of the NAIRU level) will ensure subdued wage pressures for the next many quarters. Inflation expectations have held stable, but energy prices have increased since the last meeting and are likely to be mentioned as a risk. Nothing should have changed the committee’s view on resource slack and we expect the statement to reiterate that “inflation will remain subdued for some time”. 
Bias and policy outlook: An article in the Financial Times on October 23 cited Fed
officials considering changing the central phrase in the FOMC statement of “keeping rates exceptionally low for an extended period”. The reason for such a change would be to prepare markets for an eventual rate hike. We believe it is too early for this. We believe that the Fed will prepare the ground for a statement change through speeches or testimony first and recent comments from central FOMC members have not changed tune. That said the Fed is likely to be warming up for a gradual change of market expectations. However, expectations tend to change rapidly rather than gradually. A change to the extended period phrase in the statement would likely cause a substantial spike in yields – a risk that we do not believe the FOMC is ready to take as yet. We do not expect the first rate hike before late next year. We thus expect the “extended period” phrase to be kept in place and any change to the wording in the statement to be minor.

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Published on  Mon, Nov 2 2009, 17:15 GMT