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August 9, 2005
FOMC press release
Read it here. I reproduce the key paragraphs below.
The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. Aggregate spending, despite high energy prices, appears to have strengthened since late winter, and labor market conditions continue to improve gradually. Core inflation has been relatively low in recent months and longer-term inflation expectations remain well contained, but pressures on inflation have stayed elevated.
The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.
Analysis to follow.
UPDATE: The risk assessment is identical to the last press release. ("Measured pace" lives!) The outlook is almost identical. I print it again below with the previous release's words in parentheses and italics where they differ. New language is in bold.
The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. Aggregate spending, despite high energy prices, appears to have strengthened since late winter, (Although energy prices have risen further, the expansion remains firm) and labor market conditions continue to improve gradually. Core inflation has been relatively low in recent months and longer-term inflation expectations remain well contained, but pressures on inflation have stayed elevated. (Pressures on inflation have stayed elevated, but longer-term inflation expectations remain well contained.)
What is the message? Economic performance has been good despite high energy prices, and the high energy prices haven't spilled over into the rest of the economy (core inflation remains low). Other than that, it's pretty much what we've seen before. So far, the market is yawning. I guess that's an appropriate reaction. Stay tuned to see if there is any change once the words sink in.
UPDATE #2 (1:50pm): The 10 year bond is actually up a few ticks. Considering that this morning, the Forbes piece that I quoted earlier seemed to be of the opinion that the bond market is looking for a hawkish statement one might consider the current reaction to be a little strange. I didn't see anything all that "hawkish". The only difference between this statement and the previous one on inflation is the statement today that core inflation has been low in recent months. Of course, there is nothing in the statement to suggest that the rate hikes are over either. And maybe that's what the market really wanted to see. I'm not jumping up and down over that. Though I don't think another one or two quarter point moves will throw us into a tailspin, I worry that the FOMC has painted themselves into a corner linguistically. How are they going to break it to the market that the rate hikes are about to pause? Granted, that may be irrelevant at the moment if the fed funds futures market is correct, but it's something they'll have to deal with eventually. The end result of this statement is to tell the bond market "don't worry; be happy" and the yield curve flattens out again. This can't go on forever.
But it looks like it will go on for a few more weeks. Right now, I am anticipating a scenario where we get two more rate hikes to get the funds rate to 4% and then a pause at the December meeting. By December, the housing market might be softening and inflation will hopefully still be contained. The holiday spending season would be a good time for a break in such a long (by that time almost 18 month) string of rate hikes. Many people regard 4% as pretty close to neutral, and that would be a good time for Greenspan to hand over the reins to his successor.
Of course, we don't have a successor yet, but that's a topic for another day.
But that scenario presupposes that the Fed can give the market a hint that the rate hikes to which the bond market seems to have become addicted are about to end. My guess is that those hints will be dropped in speeches by Fed governors and presidents. So far I haven't heard much. It will indeed be an interesting autumn for monetary policy. I just hope it doesn't give way to the winter of our discontent.
UPDATE (yet again): For more, check out Mark Thoma, and PGL at Angry Bear. The Capital Spectator is even more worried than I am.
UPDATE: Still more econ bloggers checking in. See also macroblog, New Economist, and Brad DeLong.
Posted by William Polley at August 9, 2005 1:18 PM
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Comments
It seems to me that "appears to have strengthened" is more cautious than "remains firm". Perhaps my intrepretation of FEDspeak is incorrect or I'm placing too much emphasis on FED lexicology. But I read that as a slightly weaker economic forecast and I wasn't surprised the ten year rallied on the statement (yield dropped from ~ 4.43% to 4.39%)
Best Wishes!
Posted by: CalculatedRisk at August 9, 2005 4:26 PM
Perhaps. You could also read it as a reference to 2nd quarter GDP which I (and many others) noted had very strong final sales (that drew down inventories). If that is the case, it sounds more optimistic. It has a ring of "stay the course, everything is going to be fine" to it. Make no mistake, I believe there are a lot of reasons to be optimistic. But I am concerned that they might be going too far--as they almost did in the mid 1990s (the "soft landing" with the "soft patch"). I'd like to avoid the soft patch. And I think we probably can if the Fed gives us a pause in the action in November and/or December.
Basically, I've been in agreement with the rationale behind the moves so far. Last June, I really would not have anticipated 10 increases in a row, but I haven't been second guessing it so far. Indeed, a few months ago, I was pretty hawkish. But if it keeps going like this past the first of the year, we're in some uncharted territory. In short, at some point in the near future every additional rate hike is going to require a pretty good sales job to keep me convinced that it's necessary. That point is probably November or December, but they need to start laying the groundwork.
That is especially true if you are correct and we're about to come into that soft patch.
Posted by: William Polley at August 9, 2005 6:13 PM
When I first read the FED statement, I scratched my head ... huh? I think it can be taken either way, but its clear we have more rate hikes coming. I'm not sure when or how they will make the transition (change the wording) to allow for a pause.
It will be interesting to see if we can avoid the British experience with housing and the drop in consumer demand - or maybe the UK will rebound after the recent repo rate cut. Obviously I think housing is going to slow signficantly in the near future and the impact on the overall economy is a huge unknown (at least to me). Where I live housing seems insane, so my view is biased by what I see every day.
Best Regards!
Posted by: CalculatedRisk at August 9, 2005 7:21 PM