FOMC Review – January: Slightly More Hawkish Than Anticipated

The January FOMC statement showed slightly more hawkish tone on economic growth though the overall stance remained unchanged – the Fed funds rate will be kept at 0-0.25% and 'economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period'. Kansas City Fed President Thomas Hoenig's dissent to keep the 'extended period' phrase was also surprising and signaled there might more hawks appearing later this year.

The Fed upgraded the growth outlook. At the beginning of the post-meeting statement, it said that economic activities since the December meeting 'continued to strengthen', compared with the phrase- 'continued to strengthen'- it used previously. Also, the committee anticipated 'the pace of economic recovery is likely to be moderate for a time', instead of 'likely to remain weak for a time'. The Fed also noted that 'business spending on equipment and software appears to be picking up', although 'investment in structures is still contracting'. However, in December, it said 'businesses are still cutting back on fixed investment, though at a slower pace'.

On the other hand, the Fed erased the statement mentioned about improvement in housing market sector. Concerning inflation, the Fed's forecast is similar to the previous meeting as substantial resource slack are 'continuing to restrain cost pressures and with longer-term inflation expectations stable, inflation is likely to be subdued for some time'. Policymakers continued to expressed concerns on the job market. While continuing to acknowledge 'the deterioration in the labor market is abating', the statement pointed 'weak labor market and modest income growth' as key factors constraining improvement in household spending.

Concerning changes in monetary policies, the fed stated it would be 'closing' down a number of liquidity programs on February 1. It also announced that the temporary liquidity swap arrangements between the Fed and other central banks will expire on February 1. Furthermore, the Fed would also be winding down the TAF, with the last auction occurring on March 8. Although the schedule on exiting the liquidity programs was largely the same as what was announced previously, the firmer tone signaled the central bank believes the economic conditions can sustain without these stimulus.

Kansas City Fed President Thomas Hoenig voted against the policy action as he believed that 'economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted'. Although we do not believe the dissent would trigger a early tightening by the Fed, it suggests that as economy shows strong recovery, more Fed members will prefer speeding up the tightening process.