By Steven K. Beckner
WASHINGTON (MNI) – Faced with the worst market turbulence since the
outbreak of the financial crisis in late 2008, a sharply divided group
of Federal Reserve policymakers erred on the side of caution, though not
inactivity, Tuesday.
The Fed’s policymaking Federal Open Market Committee was content at
the usually somnambulant August meeting to define just how long it will
leave the federal funds rate between zero and 25 basis points. But it
laid the groundwork for more aggressive action, possibly another round
of quantitative easing if economic and financial conditions continue to
worsen.
There had been speculation that the Fed might follow in the
footsteps of the European Central Bank and resume large scale bond
buying at this meeting to push down long-term interest rates. For
now, it chose to refrain from launching a so-called “QE3,” but
it left the door open to doing so in the future.
It vowed to “regularly review the size and composition of its
securities holdings” and to employ all of its monetary policy tools “as
appropriate.” What’s more, it strongly hinted at concern that jobs and
inflation are diverging from its “dual mandate.”
While delaying any direct policy action, Chairman Ben Bernanke and
his colleagues are not standing idle in face of what they call
“considerably slower” growth, labor market “deterioration” and
diminishing inflation.
With three Federal Reserve Bank presidents dissenting, the FOMC
pledged to hold short-term rates near zero through at least the middle
of next year — the first time it has so precisely defined its
oft-repeated “extended period” of an “exceptionally low” funds rate.
Dallas Federal Reserve Bank President Richard Fisher, Minneapolis
Fed President Narayana Kocherlakota and Philadelphia Fed President
Charles Plosser voted against the change in the so-called “forward
guidance” section of the policy statement. It is the first time since
Nov. 17, 1992 that there have been as many as three dissents at an FOMC
meeting.
The meeting took place against a tumultuous financial backdrop that
threatened an already fragile economy. Enactment a week ago of
legislation to raise the federal debt ceiling and to provide for up to
$2.4 trillion in reductions in the rate of growth of government spending
failed to stem stock selling on Wall Street. And the sell-off
accelerated after Standard & Poor’s downgraded U.S. government debt
Friday night.
Even before the flight from stocks into safe haven investments such
as gold, the economy was showing signs of stalling. Second quarter GDP
growth was estimated at a disappointing 1.3% following a downwardly
revised first quarter rate of 0.4%. And there were signs that the slump
was continuing into the third quarter, as evidenced by surveys of
corporate purchasing managers. Last Friday’s July employment report
showed a welcome 117,000 increase in non-farm payrolls and a dip in the
unemployment rate to 9.1%, but the latter was explained in good part by
another large drop in the work force, as more people said they had
stopped looking for work.
America’s debt woes, compounded by the European debt crisis, put
pressure on the Fed to take some sort of action to reassure investors
and stabilize markets.
On Sunday, Bernanke joined with his G-7 counterparts in pledging to
act as necessary to provide liquidity and aid market functioning. But
market participants were looking for more in the way of monetary
stimulus from the FOMC.
MNI anticipated that the Commmittee was unlikely at this meeting to
resume quantitative easing little more than a month after the completion
of the $600 billion QE2 and reported that some tinkering with the
“extended period” language was “more likely.” And that is much the way
it played out.
The FOMC policy statement was a significant departure, however,
from the one issued on June 22, which already reflected a downgrading of
the economic outlook from April.
In the June statement, the FOMC said “the economic recovery is
continuing at a moderate pace, though somewhat more slowly than the
Committee had expected,” and it added that “recent labor market
indicators have been weaker than anticipated.”
This time the characterization of economic conditions was much
drearier: “Information received since the Federal Open Market Committee
met in June indicates that economic growth so far this year has been
considerably slower than the Committee had expected,” the Aug. 9
statement said. “Indicators suggest a deterioration in overall labor
market conditions in recent months, and the unemployment rate has moved
up.”
The statement went on to observe that “household spending has
flattened out, investment in nonresidential structures is still weak,
and the housing sector remains depressed. However, business investment
in equipment and software continues to expand.”
Until recently, Fed officials have been saying that the economic
slowdown was due to “temporary factors,” although Bernanke acknwoledged
at his June 22 press conference that some of the weakness might prove to
be “longer lived.”
Now the Fed’s conviction that “temporary” factors overwhelmingly
explain the slump has been largely jettisoned. “Temporary factors,
including the damping effect of higher food and energy prices on
consumer purchasing power and spending as well as supply chain
disruptions associated with the tragic events in Japan, appear to
account for only some of the recent weakness in economic activity,” the
new statement says.
The FOMC has also altered its outlook for inflation. After saying
in June that “inflation has picked up in recent months….,” it now says
“more recently, inflation has moderated as prices of energy and some
commodities have declined from their earlier peaks….”
Moreover, the FOMC statement hints at further disinflation — a
precondition for a possible future QE3.
After saying that it “expects a somewhat slower pace of recovery
over coming quarters,” that it “anticipates that the unemployment rate
will decline only gradually toward levels that the Committee judges to
be consistent with its dual mandate” and that “downside risks to the
economic outlook have increased,” the FOMC said it “also anticipates
that inflation will settle, over coming quarters, at levels at or below
those consistent with the Committee’s dual mandate as the effects of
past energy and other commodity price increases dissipate further.”
It pledged to “continue to pay close attention to the evolution of
inflation and inflation expectations.”
The FOMC’s dual references to shortfalls from its “dual mandate” of
maximum job growth and price stability is significant. It could set the
stage for an eventual resumption of quantitative easing if economic
growth, employment and inflation are seen as falling short of that
mandate in coming weeks.
The FOMC could conceivably act before the next regularly scheduled
meeting on Sept. 20 if necessary. In the meanwhile, Bernanke will be
giving an eagerly awaited keynote address at the Kansas City Fed’s
annual Jackson Hole symposium on Aug. 26. Last year, he used the
occasion to signal the advent of QE2.
For now, the FOMC has decided to leave policy on hold. Not only is
it leaving the funds rate unchanged near zero and promising to keep it
there “at least through mid-2013,” it is maintaining its policy of
preventing the Fed’s bloated balance sheet from shrinking by reinvesting
principal payments from its securities holdings.
But its familiar promise to “regularly review the size and
composition of its securities holdings and is prepared to adjust those
holdings as appropriate” takes on new meaning in the current context.
And it went a bit further than in the past in its subsequent
paragraph: “The Committee discussed the range of policy tools available
to promote a stronger economic recovery in a context of price stability.
It will continue to assess the economic outlook in light of incoming
information and is prepared to employ these tools as appropriate.”
In toto, the statement says the Fed wants to move cautiously for
now, but that there may be much more to come unless things improve.
** Market News International Washington Bureau: 202-371-2121 **
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