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US: FedWatch

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Fed expects the economy to contract moderately in 2H08 and 1H09

Thu, Nov 20 2008, 10:07 GMT
by BBVA Bancomer Team

BBVA Bancomer

FOMC Minutes October 28-29th 2008

• Fed expects the economy to contract moderately in 2H08 and 1H09 and to overall grow at around zero in 2009
  

• Some participants saw risks to the downside on inflation
  

• We expect an additional rate cut on December 16th, 2008
  

The staff reduced its forecast for economic activity in 2H08, 2009 and 2010. It expected GDP to contract in 4Q08. Moreover, it predicted “that real GDP would continue to contract somewhat in the first half of 2009 and then rise in the second half, with the result that real GDP would be about unchanged for the year.” For 2010, the staff expects GDP growth to reach potential. The staff also lowered its forecast for both core and headline PCE inflation, assuming falling commodity and import prices as well as greater economic slack than expected at the time of the previous meeting. “Core inflation was projected to slow considerably in 2009 and then to edge down further in 2010”.

FOMC members also lowered their GDP forecasts, noting that “the worsening financial situation, the slowdown in growth abroad, and incoming information on economic activity had led them to mark down significantly their outlook for growth”. In their discussion, members also noted that “downside risks to economic growth had increased”. Several participants expect a fiscal stimulus in the next quarters, though they are uncertain about its magnitude and effectiveness.

Participants continued to expect inflation to move down in coming quarters as a result of falling energy and other commodity prices, dollar appreciation and slower economic activity. Some participants “saw a risk that over time inflation could fall below the levels consistent with the Federal Reserve’s dual objectives of price stability and maximum employment”, suggesting that inflation risks are now tilted to the downside.

Regarding monetary policy some members noted that “the possibility of reduced policy effectiveness and the limited scope for reducing the target further were reasons for a more aggressive policy adjustment; an easing of policy should contribute to a beneficial reduction in some borrowing costs, even if a given rate reduction currently would elicit a smaller effect than in more typical circumstances, and more aggressive easing should reduce the odds of a deflationary outcome”.

Bottom line. With both economic activity and inflation slowing down, the minutes point to an increased likelihood that the FOMC will reduce its target rate by 50 bp during its next meeting (December 16th). Given that downside risks to growth persist and that there is an explicit concern that core inflation could fall below Fed’s comfort zone, there is a significant chance to see a prolonged period of low interest rates.

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Published on  Thu, Nov 20 2008, 15:00 GMT