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Preview: FOMC November rate decision

Wed, Nov 4 2009, 16:46 GMT
by RANsquawk Research Team

RANsquawk

The FOMC is expected to keep interest rates in a 0-0.25% range at the November meeting and could refrain from major changes to the accompanying statement after much speculation last week.

On the whole, analysts believe the Fed will stick to the wording: rates to stay low for an ‘extended period’ for at least one more month as inflationary pressures continue to remain subdued due to the enormous slack in the economy and high unemployment levels. Though, some analysts believe there is still a slim chance they may alter the language, perhaps to please the growing chorus of global central banks that have expressed concern over USD weakness.

This would, however, seem unlikely as the Fed still foresees a bumpy recovery and this thinking was recently solidified by the pre-packaged bankruptcy of CIT Group. Also, it would be more prudent for the Fed to groom the market for changes to such a central phrase through speeches and testimony in order to avoid misinterpretation.

Moreover, commercial real estate is still a problem and this issue was highlighted by Fed official Greenlee who said that banks were still vulnerable to losses. As a result, the FOMC may wish to signal a continued accommodative monetary policy until economic conditions improve enough to warrant a change in language.

Growth/Economic Data

The US officially exited the recession last week after data showed the economy grew 3.5% in Q3 Y/Y. However, much of this growth was largely attributed to the government’s liquidity/incentive schemes such as the ‘cash for clunkers’ program and first time homebuyer tax credit. Also, on Monday ISM manufacturing expanded for a third straight month, and the employment index, which has been in contraction mode for a while, moved above 50. This looked like a positive development on the surface, but ISM’s Ore called it a ‘mirage’ and said the rise may reflect temporary hires and/or callbacks. More to the point, the high unemployment rate and lower home values continue to be a drag on growth as the US consumer reigns in spending.

Inflation

Inflation continues to trend lower, with Core PCE now sitting below the Fed’s target of 1.4%. Furthermore, wage inflation looks to be moderating and with the unemployment rate still way above the NAIRU (Non-Accelerating Inflation Rate of Unemployment) this should not be an issue in the near term. However, volatile energy prices are an ongoing concern, especially as WTI crude prices have increased around 20% since the previous FOMC meeting. Therefore, the FOMC may seek to highlight these risks in the accompanying statement.

Market Reaction

Should the Fed sound more optimistic on the economy then this could be interpreted as a tilting of monetary policy. If the Fed channels this optimism through a change in the central phrase: rates to stay low for an ‘extended period’, then the market could prepare itself for an rate hike, probably in early 2010. This would likely result in a considerable spike up in yields and a rally in the USD. However, the general consensus is that the Fed will remain cautious on the economic outlook and not make any major adjustments to the statement, in which case the market reaction is likely to be material as this would have been largely priced in already.

Sources: RTRS/BBG/FT/Fed Website

Previous Fed statement following the rate decision on September 23, 2009:

Information received since the Federal Open Market Committee met in August suggests that economic activity has picked up following its severe downturn. Conditions in financial markets have improved further, and activity in the housing sector has increased. Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.

With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.

In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt. The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010. As previously announced, the Federal Reserve’s purchases of $300 billion of Treasury securities will be completed by the end of October 2009. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.

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Published on  Wed, Nov 4 2009, 16:48 GMT