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FOMC Preview: Policy Steady, but a Lot to Discuss
June 22, 2011
By David Greenlaw | New York
The FOMC meets next Tuesday and Wednesday. As in April, the official statement will be released at 12:30pm on Wednesday, followed by Bernanke's press conference at 2:15pm. Note that this will be the last two-day meeting (and thus the last Bernanke press conference) until November.
The recent string of incoming data in the US has signaled weaker growth, but higher inflation, which appears to reinforce a Fed on hold for the foreseeable future scenario. Indeed, one or more Fed officials appeared to convey just such a message to their main press contact - Jon Hilsenrath of The Wall Street Journal. So, while the FOMC is likely to reference the recent data disappointments, we don't expect any drastic wording changes in the FOMC statement that will be released next week. One of the main items of interest will be the members' forecast revisions (released at 2:15pm). Officials downgraded their assessment of growth and pushed up their inflation estimates at the April meeting. We expect a further downward adjustment in the GDP outlook - to something probably centered around +3% for 2011.
While it doesn't appear that any near-term policy changes loom, the FOMC certainly has plenty to talk about at the June gathering. First, they are likely to discuss options for additional monetary ease. With core inflation continuing to rapidly accelerate, the bar is quite high to further stimulus - probably requiring an unemployment rate at or above 10% and a core inflation rate slipping back below 1% - but they need to begin discussing the various options. Whether you believe that QE2 was a success or not, it seems likely that further purchases of Treasury securities might not be particular helpful at this stage.
But, the Fed is not out of ammunition. Options on the table for discussion apparently include: 1) a Bank of Canada style commitment to maintain the current policy rate for a specific period of time, 2) a commitment to maintain a certain SOMA portfolio size for a specific period of time, 3) extending the average duration of the SOMA portfolio (without changing its overall size) in an attempt to put downward pressure on term yields; and 4) cutting the interest rate on reserves (IOR). All of these options have plusses and minuses associated with them and warrant considerable analysis and discussion. Although IOR is already at an extremely low level of 25bp, a further reduction (to near zero) could help to spur bank lending by essentially eliminating the return on holdings of excess reserves. Interestingly, the Fed does not seem anxious to consider yield caps at this point. In his famous 2002 speech, Bernanke indicated that a yield cap stimulus program was one of his favorite means of combating deflation once the policy rate had been reduced to zero. However, it appears that he and other Fed officials are less inclined to support such a program at this point. In any event, we suspect that Bernanke will be asked about additional forms of monetary stimulus at the press conference and it will be interesting to see how he responds.
At the other end of the policy spectrum, the FOMC may need to revisit the discussion of exit strategies that took place at the April meeting. Specifically, the minutes indicated that members supported using suspension of Treasury rollovers (at the time or shortly after the suspension of MBS reinvestments) as one of the means by which they would eventually shrink the balance sheet. However, as we have pointed out, such a policy would create a maturity gap in the Fed's SOMA portfolio and hamper the securities lending program. We suspect that most FOMC members were not aware of this technical issue, and thus there may be a staff briefing on the subject at the June meeting. We believe that a reasonable middle ground might be achieved by rolling over one-half of maturing Treasuries when the time comes to move in that direction.
Finally, a recent Bloomberg report has indicated that the FOMC is once again engaged in an active discussion of inflation targeting. This issue has been kicked around for more than a decade inside the Fed, and it has been well understood that Bernanke is a supporter but that others (led by Don Kohn) were opposed. Now that Kohn has been gone for awhile, the idea may get more traction. Still, it seems unlikely that anything drastic will happen soon. And, even if there is movement in this direction at some point down the road, it may wind up being a very modest step - such as making the current unofficial inflation target of "+2% or a little below" a bit more explicit.
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