Economic data have continued to improve and we believe that this will be noted in the FOMC statement. Inflation pressures on the other hand remain subdued. Hence we expect the statement to reiterate that the Fed funds rate will be kept exceptionally low for an extended period. Any change to this sentence would be a big market mover.

 

We expect that the FOMC will decide to gradually slow down the purchase of agency debt and MBS in the same way as it has already announced for Treasury purchases. This is likely to extend the purchases into Q1 2010 and the decision is likely to be announced at this week's meeting.

The meeting could very well turn out to be a non-event. Nevertheless, we find that the risk-reward in positioning for higher yields is better than positioning for lower yields given the current market pricing of Fed hikes.

 

Activity: Since the latest FOMC rate decision on 12 August, economic data have in general improved further. Consensus expectations for H2 2009 have been revised upwards and most now see growth close to trend. Improvement has been widespread with housing data, data for the manufacturing sector and latest consumer spending all surprising on the upside. The committee will receive new Fed staff forecasts ahead of the meeting and these should show upward revisions as well. The soft spot in the economy continues to be the labour market. Although job losses have moderated significantly, unemployment continues to rise fast and jobless claims data have still not shown a convincingly downward trend. We expect the FOMC to upgrade the assessment of incoming growth indicators. The latest Fed forecast implied growth of around 1% in H209 - this is set to be revised up. A dovish twist is likely to be incorporated through the comments on labour market conditions.

Inflation: Core inflation is trending down, with core PCE now below the Fed's comfort zone, and will continue to do so for the next many months. Wage inflation has moderated significantly and an unemployment rate way above the NAIRU (even taking into consideration the uncertainty of the NAIRU level) will ensure subdued wage pressures for the next many quarters. Energy prices have stabilised since the last meeting which means that the reference to rising commodity prices is likely to be removed from the statement. In addition we expect the statement to reiterate that the "Committee expects that inflation will remain subdued for some time."

Bias and policy outlook:. Speculations that the FOMC will move away from its current easing bias to a more neutral stance have been fuelled by the rhetoric of some regional Federal Reserve bank presidents recently. We think it is too early for this. The signals from the committee's inner circle have been quite clear in stressing that the monetary policy rate will be kept low for a long time to come. A change in the stance would likely be reflected in changes in the following two sentences in the statement: firstly, that Fed will "employ all available tools to promote economic recovery and to preserve price stability" and secondly that "economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period". We expect the statement to keep both sentences unchanged and hence the FOMC to remain at an easing bias.

 

 

 

 

 

 

 

 

 

 

 

 

 

FOMC key statements

Bernanke (neutral, voter) Sept 15: "Even though from a technical perspective the recession is very likely over at this point, it's still going to feel like a very weak economy for some time (..) then unfortunately unemployment will be slow to come down.

Yellen (dove, voter) Sept 14: "Our foot is down on the pedal of stimulus as far as we can possibly go."

Lacker (hawk, voter) Sept 14: "before we get to thinking about exit, we may need to consider whether to continue adding more stimulus up to the fully authorized amount of our purchases."

Kohn (neutral, voter) Sept 10: "Paying interest on reserve balances also has important benefits and will play a key role in our exit from unusually accommodative policies when the time comes." "As the FOMC has said, that time is not likely to come for an extended period."

Evans (neutral, voter) Sept 9: We're looking for what a lot of people would describe as a 'U'-shaped recovery. It's not going to be a strong expansion coming out of this and that's going to be associated with the rise in unemployment."

Fisher (hawk, non-voter) Sept 9: Given the lag between the time monetary policy is initiated and when it impacts the economy, that wind-down process needs to begin as soon as there are convincing signs that economic growth is gaining traction."

Extracts from FOMC minutes:

A number of participants noted that a similar tapering of agency debt and MBS purchases could be helpful in the future as those programs approach completion.

The staff presented an update on the continuing development of several tools that could help support a smooth withdrawal of policy accommodation at the appropriate time. These measures include executing reverse repurchase agreements on a large scale, potentially with counterparties other than the primary dealers; implementing a term deposit facility that would be available to depository institutions in order to reduce the supply of excess reserves; and taking steps to tighten the link between the interest rate paid on reserve balances held at the Federal Reserve Banks and the federal funds rate With the unemployment rate anticipated to increase somewhat during the remainder of 2009 and to decline only gradually in 2010, the staff still expected core PCE inflation to slow substantially over the forecast period; the very low readings on hourly compensation lately suggested that such a process might already be in train.

Most participants saw the economy as likely to recover only slowly during the second half of this year, and all saw it as still vulnerable to adverse shocks.

Most participants anticipated that substantial slack in resource utilization would lead to subdued and potentially declining wage and price inflation over the next few years; a few saw a risk of substantial disinflation. However, some pointed to the problems in measuring economic slack in real time, and several were skeptical that temporarily low levels of resource utilization would reduce inflation appreciably.

The improvement in financial markets was due, in part, to support from various government programs, and market functioning might deteriorate as those programs wind down.

Labor market conditions remained of particular concern to meeting participants. The unusually large fraction of those who were working part time for economic reasons and the unusually low level of the average workweek, combined with indications from business contacts that firms would resist hiring as sales and production turn up, also pointed to a period of modest job gains and thus a slow decline in the unemployment rate.

The future path of the federal funds rate would continue to depend on the Committee's evolving outlook, but, for now, given their forecasts for only a gradual upturn in economic activity and subdued inflation, members thought it most likely that the federal funds rate would need to be maintained at an exceptionally low level for an extended period. With the downside risks to the economic outlook now considerably reduced but the economic recovery likely to be damped, the Committee also agreed that neither expansion nor contraction of its program of asset purchases was warranted at this time.

Statement from August 12 meeting:

Information received since the Federal Open Market Committee met in June suggests that economic activity is leveling out. Conditions in financial markets have improved further in recent weeks. Household spending has continued to show signs of 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 but are making progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.

The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.

In these circumstances, the Federal Reserve will employ all available 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. As previously announced, 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 up to $1.25 trillion of agency mortgagebacked securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve is in the process of buying $300 billion of Treasury securities. To promote a smooth transition in markets as these purchases of Treasury securities are completed, the Committee has decided to gradually slow the pace of these transactions and anticipates that the full amount will be purchased by the end of October. 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.

FOMC ornithology