The FOMC Meeting: A Preview

As the Federal Open Market Committee meets this week it continues to face a sluggish economy, but will be buoyed by a stronger-than-expected third-quarter reading for gross domestic product. Nonetheless, the economy remains constrained by slow income growth and weak job creation as suggested in the statement issued following the September 22-23 meeting. The most recent Beige Book said the nation’s economy is showing increasing signs of stabilizing or improving, but while the summary suggested the economy had stopped deteriorating, the details were not as positive.

According to the Beige Book, “reports of gains in economic activity generally outnumber declines, but virtually every reference to improvement was qualified as either small or scattered.”

The Beige Book issued two weeks ago said residential real estate and manufacturing were “the more positive reports” but cautioned “commercial real estate was reported to be one of the weakest sectors, although reports of weakness or moderate decline were frequently noted in other sectors.”

While inflation remains contained, that is both a positive and a negative.Inflation is generally seen as too many dollars chasing too few goods. In the current environment, the dollars created by the expansion of the money supply have largely not been put into use.The excess capacity available due to weak production and capacity utilization should allow the economy, as it recovers, to meet improved demand until inflationary pressures begin. That would give the FOMC time to fine-tune its monetary policy and unwind its quantitative easing path – expanding money supply without lowering rates – at a measured, controlled pace.

Economic Environment (compared with September 22-23 meeting)

Overall Economy

GDP:

GDP: A 3.5% (annualized) increase in the third quarter compared with a 1.0% decline (later revised to a 0.7% decline) in the second quarter after a 6.4% decline in the first quarter; there is, though, skepticism about the sustainability of the increase; LESS WEAK.

Labor Markets

Payroll jobs: Fell 263,000 in September, a steeper decline than the loss of 216,000 jobs in August (later revised to a loss of 201,000 jobs). WEAKER.Unemployment Rate: Rose to 9.9% from 9.7%. WEAKER.Initial Unemployment Insurance Claims: four-week average: 526,000 improved from 563,000 LESS WEAKWages (Average weekly earnings): Down 0.2% month-month compared with an increase of 0.4% in advance of the September meeting. WEAKER

Consumer Activity

Retail sales: Sales (ex auto) were up 0.5% in September compared with an increase of 1.1% in August WEAKER (reported nominally and influenced by higher prices).Confidence: Conference Board index 47.7% in October compared with 54.1 in August (last report before the September FOMC meeting) WEAKER

Housing

Home sales: New home sales were lower in September than in July (last report before the September FOMC meeting) WEAKERExisting home sales were each higher in September than in July (the most recent reporting month). STRONGERHome values moved still lower (year-year comparison) in August (latest reporting month) according to the Case Shiller Home Price Index, but prices decline in the Federal Housing Finance Agency Home Price Index. LESS WEAK

Inflation

CPI: Core inflation per the consumer price index was higher in September (1.5%) than in August (1.4%) but still low by historic standards: STRONGER PCE: The core inflation rate tracked through the personal income and spending report was 1.3% September, down from 1.4% in July (the last report before the September FOMC meeting). WEAKER

Manufacturing:

Both the industrial production index and capacity utilization index are up from levels ahead of the September meeting: STRONGER

What to look for

The FOMC statement typically contains five key paragraphs: A summary of the FOMC decisionA growth assessmentAn inflation outlookA monetary policy / risks outlookA recap of the vote

Comparison: September 23 / August 12 FOMC Statements

Information received since the Federal Open Market Committee met in August suggests that economic activity has picked up following its severe downturn. Conditions in financial markets have improved further, and activity in the housing sector has increased. Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales.

Information received since the Federal Open Market Committee met in June suggests that economic activity is leveling out. Conditions in financial markets have improved further in recent weeks. Household spending has continued to show signs of stabilizing but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing but are making progress in bringing inventory stocks into better alignment with sales.

The FOMC was firmer in September in its assessment of economic activity (“has picked up” instead of “suggests that economic activity is leveling out") but hedged on its assessment of household spending (“seems to be stabilizing” instead of “has continued to show signs of stabilizing.”)

Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability. With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.

Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability. The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.

The FOMC repeated its long-term forecast and defense of its policy actions and reiterated its views on the impact of energy prices on inflation by eliminating the reference to “the prices of energy and other commodities.”

In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. 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 are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. 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 are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

The FOMC restated its intention to keep interest rates low “for an extended period.” If this key phrase is changed in the statement Wednesday markets will react strongly.

To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt. The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010. As previously announced, the Federal Reserve’s purchases of $300 billion of Treasury securities will be completed by the end of October 2009. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve is in the process of buying $300 billion of Treasury securities. To promote a smooth transition in markets as these purchases of Treasury securities are completed, the Committee has decided to gradually slow the pace of these transactions and anticipates that the full amount will be purchased by the end of October. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

The FOMC extended (to the first quarter of 2010 from the end of 2009) its program to purchase agency debt but reiterated its plan to end its program of purchasing Treasury securities but suggested the revised schedule is subject to change.

Mark Lieberman is the senior economist for the Fox Business Network. Prior to joining FOX, he served as first vice president and manager of economic analysis and research at Washington Mutual in New York. Before that, he served as senior vice president at Dime Savings Bank of New York (which was later acquired by Washington Mutual), where he specialized in credit and risk management. He is a member of the Executive Committee of the New York Association for Business Economics. He has a degree in Economics from the Wharton School of the University of Pennsylvania.

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