Wednesday, August 10, 2011

The Fed

It was a sensible statement from the Fed this morning. They have acknowledged their growth forecasts have been too optimistic and that the so-called recent “transitory factors” only explain some of the recent weakness in economic growth. As we have commented previously, the US was going into another soft-patch for growth regardless of the Japan earthquake, the weather disruptions and high commodity prices constraining household budgets. Those factors have simply served to exacerbate current weakness.

It was important, however, that the Fed didn’t buy-in to the panic currently gripping equity markets and do more than they needed to do. There were some expectations in the market that QE3 was going to get announced today. The wise words of Homer Simpson come to mind - “Doh!”

To go down that step, the Fed needs to believe their dual mandates of full employment and price stability are at threat. At this point the FOMC “expects a somewhat slower pace of recovery over coming quarters…and anticipates that the unemployment rate will decline only gradually…” On inflation, the FOMC “anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate…” Those views, with which we concur, are not consistent with another round of quantitative easing. However, we have no doubt the Fed will go down the QE3 path should that need arise, but that’s a debate for later.

What they have done is put a time-frame on their previous comments around the expected “extended period” for exceptionally low interest rates: “The Committee currently anticipates that economic conditions…are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.” This has led to a further rally in the short-end of the US yield curve from what were already expensive levels. It’s incredible that only a few short months ago markets were pricing in a rise in fed funds later this year. Anything to say to that Homer?