FOMC Preview – Meeting Coming Up On Tues Aug 10 (2:15pmET)

Bottom Line – despite a lot of talk about incremental accommodative actions on the part of the Fed, the Aug 10 statement could wind up looking pretty similar to the last one published on June 23 (w/a modest downgrade to the language describing the economic outlook).     

·         Economic Growth

o        What they said on June 23: “Information received since the Federal Open Market Committee met in April suggests that the economic recovery is proceeding and that the labor market is improving gradually. Household spending is increasing but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level”

o        Outlook for Aug 10: this language will probably be downgraded slightly.  The recovery will probably still be characterized as “proceeding” (i.e. there isn’t a contraction occurring) but the tone around labor, spending, housing, etc, will prob. sound more cautious. 

·         Financial Conditions

o        What they said on June 23: “Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad. Bank lending has continued to contract in recent months”

o        Outlook for Aug 10: this language may actually be upgraded slightly to reflect the improvements in Europe over the last month.  The tone re domestic bank lending will prob. remain unchanged. 

·         Inflation

o        What they said on June 23: “Prices of energy and other commodities have declined somewhat in recent months, and underlying inflation has trended lower. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time” 

o        Outlook for Aug 10: a lot of the big commodity prices are higher since the June meeting, but the underlying inflation readings on the economy remain very subdued.  It will be interesting to see if any acknowledgment is made about the recent Bullard deflation threat paper, although this is probably unlikely.  Overall, aside from some commodity volatility, the basic thrust of the inflation language should remain unchanged. 

·         Rate Policy

o        What they said on June 23: “The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period”

o        Outlook for Aug 10: the language on rates will probably remain unchanged.  There is some speculation that they may define what “extended period” means (i.e. 2 years) to ensure the markets that policy will remain accommodative for a truly long time.  

·         Further policy options

o        What they said on June 23: “The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability”

o        Outlook for Aug 10: from JPMorgan’s M Feroli – this line could be beefed up to express an increased willingness to take action. One candidate change would be to replace the “will employ its policy tools as necessary” with the slightly stronger message from Humphrey-Hawkins “is prepared to take further policy actions as needed.” Such a phrasing would not necessarily constitute a bias, per se, but would signal that the committee is situated to quickly provide more monetary stimulus (M Feroli).

·         Voting

o        What they said on June 23: “Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy action was Thomas M. Hoenig, who believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to a build-up of future imbalances and increase risks to longer-run macroeconomic and financial stability, while limiting the Committee’s flexibility to begin raising rates modestly”

o        Outlook for Aug 10: from M Feroli: Hoenig may well dissent again, even though it seems unadvisable. One interesting theory we’ve heard is that Rosengren casts a dovish dissent. We hope that doesn’t happen, as it would only create flashbacks to late 2007 when he last dissented, and the rest was history.

·         Anything else?

o        From M Feroli - Another option on the table is to reinvest the proceeds of maturing or prepaying MBS on the Fed’s balance sheet. The perceived benefit of this option is that it will stabilize the size of the Fed’s balance sheet, which arguably implies a more neutral stance than the currently shrinking balance sheet. While this is a minor policy step, it would represent a shift in stance. While certainly a risk, we don’t think this step will be taken at next week’s meeting.