WASHINGTON — Federal Reserve policymakers stayed very much in a holding pattern at the end of a two-day Federal Open Market Committee meeting Wednesday, leaving their lax monetary policy unchanged and making relatively minimal changes to their policy statement.
The FOMC did not clearly signal any delay in the "tapering" of the Fed's large-scale asset purchases beyond the tentative timetable set forth by Fed Chairman Ben Bernanke following the June meeting.
There was one not insignificant change in the latest statement. In apparent deference to members who had expressed concern about disinflation, the FOMC did add language warning that "inflation persistently below its 2% objective could pose risks to economic performance."
However, the Committee immediately added that "it anticipates that inflation will move back toward its objective over the medium term." And it repeated that it believes below-target inflation to be partially due to "transitory influences."
What's more the statement reiterated that "longer-term inflation expectations have remained stable." This latter point is key. Fed officials would be far more concerned about excessive disinflation if inflation expectations were falling.
Speculation that the FOMC might introduce a new, lower inflation floor to go with its upper or "threshold" of 2.5% proved unfounded.
With the new language on "persistently" below-target inflation, St. Louis Federal Reserve Bank President James Bullard voted with the majority after dissenting on June 19 in the belief that the FOMC "should signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings."
The only dissenter was Kansas City Fed President Esther George, who once again "was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations."
The FOMC also substituted the word "modest" for "moderate" to describe the recent pace of economic growth, but it would be hard to define the difference in the minds of most people.
The only other new element was an observation that "mortgage rates have risen somewhat," as indeed they have even before Fed Chairman Ben Bernanke signaled on behalf of his colleagues that it could reduce its bond purchases from $85 billion per month "later this year" and perhaps end them by the middle of next year.
The note on mortgage rates came in the same sentence in which the Fed repeated that "fiscal policy is restraining economic growth." But at the same time, the statement reiterated that "the Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall."
Fed officials have kept a wary eye on rising mortgage and other long-term rates over the past two months and, at times, have tried to modulate market fears of higher rates - with some success. But neither the matter-of-fact observation that mortgage rates have risen nor the stronger language on below-target inflation necessarily mean the FOMC will delay dialing back its Treasury and mortgage backed securities purchases.
The timing of a "tapering" will depend chiefly on the pace of job and GDP growth.
For now, the FOMC is continuing its third round of "quantitative easing" -- designed to hold down mortgage and other long-term interest rates -- unabated. It will keep buying $45 billion per month of longer term Treasury securities and $40 billion per month of MBS. To prevent any passive shrinkage of its balance sheet, the Fed will also continue reinvesting proceeds of MBS in its portfolio and rolling over its Treasury holdings.
Furthermore, the Fed is keeping the overnight federal funds rate and in turn other short-term rates near zero, where they've been for going on five years. And the FOMC repeats it will keep those rates very low "for a considerable time" after it stops buying bonds - at least until the unemployment rate falls to 6.5%. That is widely assumed to mean no rate hikes until sometime 2015 at the very earliest.
The FOMC statement necessarily leaves in doubt when the Fed will begin reducing its monthly bond purchases. Although many Fed watchers are looking toward Sept. 17, when the FOMC once again revises its economic projections and Bernanke holds a press conference, the Fed chief took care to tell Congress a few weeks ago that there is no "preset" schedule for reducing bond purchases.
And, when asked on July 18 by Sen. Charles Schumer, whether September is the most likely time for tapering to begin, Bernanke said, "it's way too early to make any judgment."
The key, as Bernanke has repeatedly made clear, is whether the economy is perceived to be growing fast enough to sustain progress on improving labor market conditions.
Although he has placed less stress on below-target inflation, Bernanke did say following the June 19 FOMC meeting that "one of the preconditions for the policy path that I described [reducing purchases "later this year" and ending them mid-2014] is that inflation begin at least gradually to return towards ... our 2% objective."
The economic data have been mixed in recent weeks. As the FOMC began its second day of discussions, the Commerce Department announced a stronger than expected 1.7% "advance" estimate of second quarter GDP growth, but this was accompanied by substantial downward revisions to the prior two quarters. Second quarter growth was revised down from 1.8% to 1.1% and fourth quarter growth from 0.4% to 0.1%.
In an early indication of third quarter economic activity, the MNI Chicago purchasing managers' business barometer rose in July from 51.6 to 52.3, but that was considerably less than expected.
On a somewhat more encouraging note, despite modest economic growth and uncertainty about the outlook, there was evidence of continued substantial job gains. Payroll processor ADP reported that private sector employment rose by 200,000 in July, following an upwardly revised 198,000 June rise.
On the other hand, the Chicago purchasing managers survey showed a slower pace of expansion in factory payrolls in July. Another interesting element of the Chicago PMI was a sizable jump in the "prices paid" component, which points in the same direction as some other recent inflation indicators.
To justify a phase-out of QE3, Bernanke and most of his fellow policymakers will primarily want to sustain a fast enough pace of job growth to reduce unemployment. They will want to see faster second half growth, in keeping with their latest economic forecasts.
In their June Summary of Economic Projections, FOMC participants anticipated that second half growth would be strong to yield 2.3% to 2.6% GDP growth for the year (on a fourth quarter over fourth quarter basis). And they projected that growth would accelerate to 3.0% to 3.5% next year and to 2.9% to 3.6% in 2015.
Clouding the outlook, however, are domestic fiscal and regulatory uncertainties, as well as downside risks from Asia and Europe. Further complicating the timing of reductions in asset purchases is the inflation picture.
Minutes of the June 18-19 meeting revealed that "about half" of FOMC participants thought it would be "appropriate to end asset purchases late this year." But that gives a misleading impression of where voting members stand.
In keeping with the Chairman's statement that the FOMC envisioned ending asset purchases by the middle of next year, provided unemployment had fallen to around 7% and inflation had turned back toward 2%, the minutes show a less zealous attitude toward unwinding Q.E. among members.
"While recognizing the improvement in a number of indicators of economic activity and labor market conditions since the fall, many members indicated that further improvement in the outlook for the labor market would be required before it would be appropriate to slow the pace of asset purchases," the minutes disclosed. "Some added that they would, as well, need to see more evidence that the projected acceleration in economic activity would occur, before reducing the pace of asset purchases."
The minutes also reported that "for one member, such a decision would also depend importantly on evidence that inflation was moving back toward the Committee's 2% objective" and that "a couple of other members also worried that the downside risks to inflation had increased."
"However, several members judged that a reduction in asset purchases would likely soon be warranted, in light of the cumulative decline in unemployment since the September meeting and ongoing increases in private pay- rolls, which had increased their confidence in the out- look for sustained improvement in labor market conditions," the minutes went on. "Two of these members also indicated that the Committee should begin curtailing its purchases relatively soon in order to prevent the potential negative consequences of the program from exceeding its anticipated benefits."
Critical to whether the FOMC makes a first, perhaps modest, reduction in bond buying in September will be the tone of the July and August employment reports and a host of other data that either confirm or disappoint Fed hopes for faster GDP growth.
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