• Economic growth is sustainable; labor market remains a risk
  • Inflation will remain subdued in the near term
  • Target rate will remain at 0%-0.25% for an extended period

FOMC participants expect economic growth to continue into the fourth quarter. Better than expected spending and production data prompted an upward revision of the staff’s forecast for 4Q09 growth, but 2010 and 2011 projections remained unchanged. Better alignment of business inventories with sales, growth in consumer spending apart from autos and heightened demand for exports from growth abroad are expected to support near term growth. While members expect growth to continue, they had some questions about how much of the firming in demand was due to fiscal stimulus and some “expressed concerns about the ability of the economy to generate a self-sustaining recovery without government support.”

Weakness in the labor markets was identified to be a significant risk to economic expansion as it will impact income growth, consumer confidence, consumer credit availability and ultimately consumer spending. “Participants discussed the possibility that this recovery could… [be] characterized by a slow pace of hiring for a time even after aggregate demand picked up.” An additional risk is the increased pressure on small and regional banks from CRE deterioration. Credit could remain tight for small businesses dependent on these institutions, limiting their ability to hire, which has historically been a source of growth in period of recovery.

Discussion then turned to inflation. While participants agreed that inflation will remain subdued, some members saw risks tilted to the downside due to the elevated level of economic slack and the possibility that inflation expectations could begin to decline in response to the low level of actual inflation. However, others countered with the possibility of a rise in inflation expectations due to the “public’s concern about extraordinary monetary policy stimulus and large federal budget deficits.”

Members also agreed that current conditions did not warrant a change to the fed funds target rate or the asset purchase programs given “low levels of resource utilization, subdued inflation trends, and stable inflation expectations.” In terms of exit strategy, members agreed on the importance of transparency and reviewed the tools available. While they debated the benefits and risks of conducting asset sales prior to or concurrent with interest rate hikes, they did not discuss specific timing.

Bottom-line: The minutes and the committee’s economic outlook are in line with our baseline scenario of moderate economic growth and low but positive inflation in the near-term. The debate on inflation was intended to alleviate market concerns that the fiscal and monetary stimulus could result in high inflation. Furthermore, members continued to focus on the exit strategy. While the discussions do not indicate that a policy change is imminent, the FOMC is highlighting its commitment to transparency and reinforcing the message that the appropriate tools are available. We maintain our forecast of low interest rates for a prolonged period.