FOMC: Less Dovish, but Hikes Remain Distant

• No change to policy measures. Hoenig repeats his lone dissent.
• Growth language slightly more optimistic but no change to inflation outlook
• ‘Extended period’ retained indicating continued commitment to low rates
• Further asset purchases highly unlikely
• No change to our outlook expecting unchanged rates until late this year

Details

The assessment of activity was slightly more upbeat than in the previous statement. As expected the FOMC turned more optimistic on the labour market while on the other hand noting recent very weak housing data. Generally, the committee still expects a moderate recovery including a gradual return to higher resource utilisation. As a result, the outlook remains 3-3.5% growth, a relatively moderate rate historically.

There were no changes to the assessment of inflation. Consequently, the committee generally remains concerned about deflationary risks, a concern probably not eased by the latest round of CPI and ULC data.

The phrase: “The Committee will continue to evaluate its purchases of securities in light of the evolving economic outlook and conditions in financial markets” was removed. Although there was no explicit commitment, this essentially implies that further asset purchases are no longer an option given the current economic outlook.

The “extended period” phraseology was retained. To us (and as noted by some Fed members) this implies that rate hikes are at least six months off.

As we expected Hoenig was the lone dissenter. In fact, there were really no other obvious candidates amongst local fed presidents with voting rights set to join him. Indeed, it would be unusual to see such open disagreement among board members.

However, that does not imply that committee sentiment is static. If, as we believe, the labour market shows convincing signs of a solid turnaround in the near future, the statement could be made over as early as the April meeting with a start made to moderating the 'extended period' language. Still, moderation is likely to be very gradual. We could imagine language such as “low interest rates for a considerable period” or “for a long time” being used to replace “extended period”. Further, it is highly likely that markets would be warned of such a change by a pre-announcement in a speech by a core member (Bernanke, Kohn, Dudley, Warsh).

The discount rate was not changed, which was widely expected, as that remains a decision for the Board and not the FOMC. We think it likely we could see further discount rate normalisation in coming months such as a further 25bps increase in the spread to the fed funds rate between today's meeting and the April meeting.

Outlook and assessment

The statement does not justify any changes to our outlook for monetary policy. Given the huge slack in the economy and a non-negligible risk of core inflation coming uncomfortably close to zero, we believe the FOMC is in no hurry to hike rates.

We expect the Fed to gradually start absorbing excess liquidity (reverse repos and term deposits) mid-2010, but do not anticipate any hikes before the November meeting.

Given our current outlook, we do not believe the Fed will hike rates aggressively through 2011. Deflationary pressures and headwinds from fiscal tightening, regulation and credit markets not fully recovered are likely to make the Fed move ahead cautiously.

Current vs. previous statement

Information received since the Federal Open Market Committee met in January suggests that economic activity has continued to strengthen and that the labor market is stabilizing. Household spending is expanding at a moderate rate but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly. However, investment in nonresidential structures is declining, housing starts have been flat at a depressed level, and employers remain reluctant to add to payrolls. While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability.

With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

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, 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. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve has been purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt; those purchases are nearing completion, and the remaining transactions will be executed by the end of this month. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

In light of improved functioning of financial markets, the Federal Reserve has been closing the special liquidity facilities that it created to support markets during the crisis. The only remaining such program, the Term Asset-Backed Securities Loan Facility, is scheduled to close on June 30 for loans backed by new-issue commercial mortgagebacked securities and on March 31 for loans backed by all other types of collateral.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy action was Thomas M. Hoenig, who believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to the buildup of financial imbalances and increase risks to longer-run macroeconomic and financial stability.

Danske Bank
http://www.danskebank.com/danskeresearch

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