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FOMC: No Rate Change. Economy has slowed. Inflation subdued.
Summary
> The FOMC left the Fed funds target rate unchanged at 0% to 0.25% and expects economic conditions to warrant exceptionally low levels of the Fed funds rate for an extended period.
> The Fed's characterization of inter-meeting economic activity was more downbeat. The pace of activity has slowed in recent months but the committee continues to anticipate a gradual recovery, although the pace is likely to be “more modest in the near-term than had been anticipated.”
> In support of the recovery, the Fed “will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities.” The change in policy is seen as a way to avoid a passive unwinding of the Federal Reserve's balance sheet (tightening). Some have suggested that the policy change would be more symbolic in nature, given expectations of an additional $200 billion in reinvestments between now and the end of 2011. However, it is not unreasonable to interpret the change as moving the Fed one step closer to resuming its QE program, if the weakening of growth in recent months continues. This policy action sent bond prices higher and the dollar lower.
> The FOMC noted that it would continue to “monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.”
> Given some loss of forward momentum and the concerns of some FOMC participants over deflation risks, the day the Fed starts to normalize rates looks more and more distant. Our long-held forecast of a Fed rate hike at the end of Q2 next year is likely to be pushed back towards yearend.
Details and analysis
The economic recovery in both output and employment “slowed in recent months.” Household spending is “increasing gradually” compared to “increasing” in the last announcement. It remains constrained by “high unemployment, modest income growth, lower housing wealth and tight credit.” Business investment spending on equipment and software was characterized as rising, while spending on nonresidential structures “continues to be weak” and housing starts “remain at a depressed level.” Firms remain reluctant to hire and bank lending continued to contract. Despite the more downbeat assessment, the committee continues to anticipate a gradual recovery, although the pace is likely to be “more modest in the near-term than had been anticipated.”
Inflation Subdued
The FOMC sees inflation remaining subdued for some time due to substantial resource slack in product and labor markets that is likely to dampen cost pressures. In addition, longer-term inflation expectations remain stable. We look for core inflation measures to decelerate further during 2010. Concerns over deflation, mentioned by a few participants at the June 23rd meeting were not mentioned in the statement.
Looking Ahead
The FOMC statement maintained the view that economic conditions “are likely to warrant exceptionally low levels of the federal funds rate for an extended period.” 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.”
Technical notes:
The FOMC announced that it intends to keep its balance sheet at approximately $2.054 trillion. And will focus its purchases of Treasuries in the 2-10 yr part of the curve while refraining from buying those securities : i) with heightened scarcity value in the repo market, ii) that are the cheapest to deliver into the front-month contract, iii) that mature within 5 weeks and iv) that the System Open Market Account (SOMA) already holds near 35% of outstanding supply.
The Fed will publish its anticipated purchase amounts around the 8th business day of each month. Purchasing is anticipated to begin on August 17th and details (operation dates, settlement dates, security types to be purchased (nominal coupons or TIPS), and a maturity date range of eligible issues for each scheduled operation) will be published August 11, at 3 p.m. EDT.
Mr. Hoenig dissented once again at this meeting as “he believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted and limits the Committee's ability to adjust policy when needed. In addition, given economic and financial conditions, Mr. Hoenig did not believe that keeping constant the size of the Federal Reserve's holdings of longer-term securities at their current level was required to support a return to the Committee's policy objectives.” Mr Bullard, who recently issued a research paper that suggested keeping the rate low might not be optimal policy as it could result in an undesired steady-state of low rates and mild deflation such as experienced by Japan did not dissent.
Market Reaction
The FOMC kept rates unchanged but signaled a small easing shift in its balance sheet policies and bond prices rallied sending yields sharply lower on the thought that prospects for renewed expansion of the Fed's balance sheet had increased. The dollar sold off on the QE prospects.
The text of the FOMC statement follows:
Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Bank lending has continued to contract. Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be more modest in the near term than had been anticipated.
Measures of underlying inflation have trended lower in recent quarters and, 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 help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve's holdings of Treasury securities as they mature.
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.
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 was Thomas M. Hoenig, who judges that the economy is recovering modestly, as projected. Accordingly, he believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted and limits the Committee's ability to adjust policy when needed. In addition, given economic and financial conditions, Mr. Hoenig did not believe that keeping constant the size of the Federal Reserve's holdings of longer-term securities at their current level was required to support a return to the Committee's policy objectives.
Michael CAREY
Crédit Agricole Corporate and Investment Bank
Fixed Income Market Research
Chief Economist – North America
michael.carey@ca-cib.com
+1 212 261 7134
Tue May 03, 2016 9:51 am by Andrea ForexMart
Subject: Thoughts on FOMC Decision 
