Monday, January 26, 2015

FOMC Report; January 27-28, 2015

Bullet Points:

  • Statement largely unchanged
  • Moderate pace of economic growth language kept
  • Labor market improved
  • Inflation below SEP projection
  • No change in reinvestment of principal and interest
  • No notice of impact from weaker global growth
  • No dissenting  
  • Absence of Federal Reserve ‘Policy Path’ increasingly unsettling 

On Statement Changes

Continued moderate growth in economic activity is expected to be indicated even with some weaker data points seen since the last meeting.  Readings on inflation since the last FOMC meeting have fallen below most recent SEP projections.  The minutes of the December FOMC meeting indicated that still lower inflation was expected over the near term; “With lower energy prices and the stronger dollar likely to keep inflation below target for some time, it was noted that the Committee might begin normalization at a time when core inflation was near current levels, although in that circumstance participants would want to be reasonably confident that inflation will move back toward 2 percent over time.”

As such, there is no reason to highlight recent inflation developments differently than indicated in the last statement; “Inflation has continued to run below the Committee's longer-run objective, partly reflecting declines in energy prices.”  The Fed may choose to forgo repeating; “Market-based measures of inflation compensation have declined somewhat further; survey-based measures of longer-term inflation expectations have remained stable."

Finally, no change should be expected in the guidance statement; “the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.”  Of course there will be no reason to repeat; “The Committee sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program in October”.  If the statement continues to include “especially if projected inflation continues to run below the Committee's 2 percent longer-run goal”, this could be interpreted to mean a June FOMC meeting policy rate ‘lift-off’ is unlikely.

On Inflation Pressure and Normalization

In the December FOMC minutes, participants made clear they expected continued pressure on inflation; ‘Participants generally anticipated that inflation was likely to decline further in the near term, reflecting the reduction in oil prices and the effects of the rise in the foreign exchange value of the dollar on import prices.’  To the extent recent declines in inflation match expectations, one should wonder how much more pressure on inflation, if any, is consistent with an interest in normalizing policy ahead of reaching the 2% target.

Temporary disinflationary effects from the oil shock and higher dollar should not dissuade Fed officials from convictions that an inflation goal of 2% can be reached in the intermediate term.  Unless there is grave concern that the oil shock and stronger dollar are masking a structural change in inflation, the Fed should not be expected to require a recovery from of the most recent down tic in inflation readings before initiating a mild policy rate move away from the zero-bound.

On Recent Volatility and the Absence of Fed Policy Path

Neither labor market growth nor inflation has allowed economic agents to build confidence lately in the Fed’s projections for lifting the policy rate toward mid-year.  There is still time so that the Fed needn’t abandon data-dependent plans for following that script.  However, markets have been overly volatile as date based guidance has been abandoned while uneven progress has been made toward attaining the Fed’s dual mandate goals.  

The Fed is unlikely to return anytime soon to the employment of additional accommodation and it has indicated it is not quite ready to proceed in removing accommodation.  This middle ground between additions and subtraction to accommodation is a highly volatile period for markets.  Until such time as a Fed policy path can be more clearly envisioned by economic agents, there is little reason to expect that markets will quiet.

At the December 2013 FOMC meeting the Fed laid out plans to eliminate additional accommodation it was providing through the purchase program.  It proposed discrete incremental declines in amount of assets purchased through October 2014.  That program of accommodation dismemberment was a ‘policy prescription’ or what I like to refer to as a ‘policy path’.  This ‘policy path’ description held benefit beyond the communicated implication that the need for economic support was abating. 

To some extent the ‘policy path’ described at the December 2013 FOMC meeting (predicted in my FOMC Report) allowed economic agents through a better understanding the Fed’s intent, a greater level of confidence in being able to decipher the unfolding of forthcoming economic events.  In providing a policy path for the elimination of the purchase program, the Fed induced some greater willingness on the part of market participants to assume risk, despite the steady removal of additional accommodations.

Until such time as economic agents are again confident that they understand a policy path for Fed intent, ideally one which involves a plan for accommodation removal, there is room for continued asset price unrest and a holding back of capital-at-risk from application.  This is likely one of the strongest reasons for the Fed to move forward in advancing the policy rate, if even only slightly, above the zero bound.  Little, if any, adverse economic impact will attend slightly higher policy rates as the level of accommodation in will remain at extreme levels.  Importantly however, a small move toward accommodation removal will induce economic agents to again form longer timeframe views for Fed policy path which should be expected to increase their willingness to assume risk.       

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