Fed minutes show doves are still worried about the sustainability of the recovery. They fear renewed weakness in housing as the central bank winds down its MBS purchases and want to keep open the option of buying more MBS if a) the economic outlook deteriorates b) mortgage rates spike.
That option is still open, but I suspect it would take a big forecast downgrade and/or a large mortgage rate spike to persuade the majority of the committee to buy more MBS.
A few quick first thoughts…
1) Fed staff getting more bullish on growth but still sees core and headline inflation declining over the next two years.
2) Policymakers think the outlook has “not changed appreciably” since the November meeting.
3) Doves (plural) still worry about sustainability of growth and want to keep open the option of expanding asset purchases.
4) Policymakers disagree as to how big an impact on mortgage rates the ending of MBS purchases will have.
5) They are not worried about current asset prices or the effect of the dollar decline to date on inflation but will keep a watchful eye on both going forward.
If the Fed is bothered about primary dealers lacking the balance sheet capacity to do reverse repos on a large scale, why not use its regulatory powers to ease these constraints? The Fed might want to do as much as $500bn in reverse repos. The dealers have balance sheet space for $100bn at most.
A short-term reverse repo with the central bank ought not to be the kind of asset a bank needs to set much capital aside for, nor the kind of asset that counts against crude leverage limits. I am not an expert on the regulatory side of this but I suspect the Fed might be able to do something about this if it put its mind to it.
Another Republican swing vote that looked as if it was up for grabs has just gone against Bernanke – Kay Bailey Hutchison. Bernanke can rely on Republicans Bob Corker and Judd Gregg. But with David Vitter also saying he does not want to proceed before there is more information on AIG – and hardcore opponents Jim Bunning and Jim De Mint guaranteed No votes – that looks like at least half the Republican group on the commitee against by my calculations.
OK so it’s not exactly Goldilocks. But maybe we are seeing a post-recession version of Goldilocks – call it Goldilite. The markets must be not too hot and not too cold, but just right.
The Fed marked up its assessment of growth yesterday but made no change to its assessment of inflation. In fact recent data suggest inflation risk has gone down not up: core inflation is flat, surveyed inflation expectations have edged lower and the dollar, commodities and gold have stabilised.
The separation principle is back – this time on the US side of the Atlantic. With today’s statement the Fed is basically embracing an ECB-style distinction between liquidity policy and monetary policy.
At the onset of the crisis some Fed officials thought there was something to the separation principle idea. Others thought it was complete nonsense.
As the crisis intensified Fed officials quickly reached a consensus that it made no sense to distinguish between monetary and liquidity policy in crisis conditions when both directly and substantially influence private borrowing rates and overall financial conditions. They thought the ECB was mistaken
For investors trying to estimate when the Fed will raise interest rates, today’s statement was a non-event. The Fed upgraded its assessment of economic conditions, but did not radically revise its view of the trajectory of growth going forward and left its discussion of inflation unchanged.
It underscored its intention to complete its exit from unconventional liquidity policy soon – but drew a bright ECB-style distinction between liquidity policy and monetary policy. It left for 2010 the question of whether the unusually narrow discount rate spread falls into the first category or the second.
Not much to get excited about.
But for analysts trying to understand the arc of Fed policy from crisis to a new normal it was a bit more interesting.
The Federal Reserve on Wednesday upgraded its assessment of the economy and highlighted its intention to shut down most of its crisis-fighting liquidity facilities in early 2010. But it gave no hint of inflation concerns that could lead to it raising interest rates.
The Fed also said that it was sticking to its existing plan to taper off and complete its scheduled $1,425bn purchases of securities issued by Fannie Mae and Freddie Mac, the government-sponsored mortgage giants, by March 31. Keep reading
I’ve just written a piece for tomorrow’s FT looking at five key exit strategy questions facing the Fed.
Just to be ultra clear to the best of my knowledge the Fed has only just begun strategizing on some of these issues and has not yet decided on a concrete plan. This underscores the fact that the Fed does not expect to be raising rates soon.
Here are the five questions:
Might the Fed raise the discount rate at this week’s policy meeting? I think this is a possibility and should be considered as a risk factor. But I would not include a discount rate increase in my base case forecast for the meeting.
The Fed will I think seek to draw an increasingly sharp distinction between liquidity policy and monetary (interest rate) policy in the spirit of the ECB’s separation principle at this meeting and in subsequent communications.