The Federal Open Market Committee meets tomorrow to discuss monetary policy at its regularly scheduled confab. No one expects a rate hike, of course, but the debate about how the central bank might do more with so-called quantitative easing has the crowd buzzing…
Disappointing growth and stubbornly high unemployment is likely to leave Fed officials with the important task of deciding whether to further bump the economy with a debt-buying program, said James Hughes, a market analyst with CMC Markets. “Whether this happens is still very much up in the air, but the reaction by the major markets could well be an aggressive one. Markets could see the move as a good sign of officials seeing the problem and acting before its too late. On the other hand, a further sign of a stuttering economy could well spook the markets in to a bigger fall for equity markets,” said Hughes.
Treasury two-year yields approached an all-time low amid speculation that the Federal Reserve will resume bond purchases this week as it seeks to safeguard the U.S. economic recovery.
►Tim Duy’s Fed Watch:
Incoming data give the Fed a green light to ease further. There is frequent chatter from unnamed sources that the Fed can do more and will consider more at this Tuesday’s FOMC meeting. The public stance of Fed officials is recent weeks has tended to downplay the necessity for action at this juncture. This combination leaves the outcome of this week’s FOMC meeting in doubt. My baseline expectation is that the FOMC statement acknowledges the weakness in recent data, but leaves the current policy stance intact. There is a nontrivial possibility that the Fed either implicitly or explicitly ends the policy of passive balance sheet contraction. I believe it very unlikely that the Fed sets in motion an expansion of the balance sheet.
The Fed should, and probably will change its tune by the fall and fire up the printing presses. Its current stance of watchful waiting in the face of slowing economic growth, inflation cycling below its preferred target rate of 1.7% to 2% and naggingly elevated unemployment strikes some observers as nothing short of mind-boggling. With good reason, these critics are pushing the Fed to adopt the deflation-fighting strategy that Bernanke mentioned in 2002, when he was a newly minted Fed governor. He suggested that the Fed could always buy long-term government bonds and corporate debt to mainline more liquidity into the financial system to counteract incipient deflation.
It goes without saying that rates will remain unchanged at 0.25%. What will be of particular note will be the tone of the language used in the statement especially after Friday’s weaker then expected payrolls data.
It will also be interesting to see if renowned hawk Thomas Hoenig drops his opposition with respect to the “extended period” language. This on its own would certainly give the market something to chew over and suggest that the Fed may well have the appetite to take further measures to stimulate the economy if data fails to improve.
Recent comments by St. Louis Fed President James Bullard at the end of July suggested that there are rumblings amongst Fed members for possible new programs of asset purchases in the event the economy continues to stumble.
The Fed will obviously acknowledge the weaker data since the last meeting in June, but they might view the last two months as a “pause” as opposed to a slowdown. In his recent testimony and his speech last week, Bernanke clearly felt the economy would continue to recover.
►Danske Bank via Pragmatic Capitalism:
Recently, speculation of further easing has intensified. However, we believe that it is premature for the Fed to announce new easing measures at the upcoming meeting. That said, it is quite certain that the assessment of the economic situation will be downgraded following a range of disappointing economic data. Hence, the Fed will continue to communicate that yields will remain exceptionally low for an extended period. It will be interesting to see if Plosser votes against the extended period language again. If not, it will be a dovish sign.
We don’t expect the Fed to launch any major balance sheet initiatives or alter the interest rate on reserves at this week’s FOMC meeting. Few of the operational options open to the Fed would have any substantive effect on financial market conditions, and the FOMC cannot afford to engage in empty symbolism. In the short run, the most important task facing the FOMC is to regain control of its core policy message. Monetary policy is already stimulative, and low but positive inflation rates are likely to allow the Fed to maintain an accommodative stance for as far as the eye can see.