Tuesday, October 12, 2010

One Eye on the Fed: FOMC Minutes for Sept 21, 2010

The Fed today released the minutes from their last meeting on Sept 21. The minutes describe who attended the meeting, their fact finding observations and their conclusions. Here is a link to the FOMC Meeting minutes. The information reviewed at the September 21 meeting indicated that the pace of the economic expansion slowed in recent months and that inflation remained low.

Monetary policy is the primary tool at their discretion. They use it to accomplish the goal of  a sustained expansion, described by Bernanke in his Jackson Hole speech as "growth in private final demand--notably, consumer spending and business fixed investment." He went on to describe his outlook for consumer and business spending. "Despite the weaker data seen recently, the preconditions for a pickup in growth in 2011 appear to remain in place. Monetary policy remains very accommodative, and financial conditions have become more supportive of growth, in part because a concerted effort by policymakers in Europe has reduced fears related to sovereign debts and the banking system there. Banks are improving their balance sheets and appear more willing to lend. Consumers are reducing their debt and building savings, returning household wealth-to-income ratios near to longer-term historical norms. Stronger household finances, rising incomes, and some easing of credit conditions will provide the basis for more-rapid growth in household spending next year."

"Businesses' investment in equipment and software should continue to grow at a healthy pace in the coming year, driven by rising demand for products and services, the continuing need to replace or update existing equipment, strong corporate balance sheets, and the low cost of financing, at least for those firms with access to public capital markets. Rising sales and increased business confidence should also lead firms to expand payrolls. However, investment in structures will likely remain weak. On the fiscal front, state and local governments continue to be under pressure; but with tax receipts showing signs of recovery, their spending should decline less rapidly than it has in the past few years. Federal fiscal stimulus seems set to continue to fade but likely not so quickly as to derail growth in coming quarters."

Here is some of the information reported in the FOMC Press Release immediately following the Sept 21 meeting. "Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls. Housing starts are at a depressed level. Bank lending has continued to contract, but at a reduced rate in recent months. The Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be modest in the near term."

They had this to say in their Press Release about the goal of managing for inflation. "With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate."

The meeting minutes add depth but do not change the message. In conclusion, the worry about inflation being too low almost guarantees additional quantitative easing, most likely announced in November. What is now the more intriguing question is what form will it take. Will it be simply modifying the language of their press release following meetings, or move to a measured and spread out program of asset purchases, or a renewed program of large and concentrated purchases.

From a financial advice perspective, what are the implications of the monetary policy actions from the Fed. Any sharp economic recovery is a fantasy, meaning low, or most likely no, growth of US GDP. Inflation at more than a slow increase also seems to be lurking a ways down the road, needing a catalyst for it to become more threatening (like a major bank failure, sovereign debt default or a currency crisis). Interest rates are going to be administered at levels the Fed considers accomodative for both short-term public debt and mortgage lending rates. Keep expectations low and use risk accordingly. What feels like stability is very tenuous, balancing on a pin point. The recent rewards are attractive but are not adequate compensation for the risk conditions.