The Federal Reserve made no changes to monetary policy today and only some small changes to the language of its statement. Once again, the Fed’s comments were slightly more optimistic about the economy than they were after the prior meeting.
The Fed noted an end to the weather-related pause in growth near the end of 2012 and start of 2013, saying economic growth had returned to a moderate rate. It also recognized recent improvements in the labor market and deleted language that had previously described employment gains as “moderate.” The move suggests the Fed thinks recent job gains are better than moderate. The Fed also upgraded its assessment of the housing recovery, saying it has “strengthened further.”
Two changes to the statement were slightly more bearish. First, the Fed said fiscal policy had become more restrictive, a reference to the recent federal spending sequester. (Unlike the Fed, we think the sequester boosts business confidence, helping growth. The S&P 500 is up 3% since March 1, when the sequester went into effect.) Second, the Fed removed a reference to an ease in strains in global financial markets. The change was probably a reaction to recent news out of Cyprus.
As everyone expected, the Fed maintained its open-ended commitment to buy additional mortgage-backed securities at a pace of $40 billion per month and more long-term Treasury securities at a pace of $45 billion per month. Once again, Kansas City Fed Bank President Esther George dissented from the Fed’s decision, concerned that loose monetary policy could create future economic and financial imbalances as well as higher long-term inflation expectations.
The Fed used the meeting to develop a new set of economic projections. It’s forecast for real GDP growth and inflation did not change in any significant way. However, given the importance of the 6.5% unemployment threshold for raising short-term rates any change in that particular projection is important and the Fed’s forecast for that indicator did fall slightly for 2013-14.
The Fed now expects the unemployment rate to end 2013 at 7.4% (previously 7.55%) and end 2014 at 6.85% (previously 7.05%). Although the Fed’s expectation for the end of 2015 is essentially unchanged, the changes for 2013-14 suggest it thinks we will hit the 6.5% threshold in July or August 2015 rather than September 2015. By contrast, we still think the threshold will be reached around mid-2014.
Despite the change in economic projections, there were no significant changes in the Fed’s projections for short-term rates. The last time the Fed released its forecast, in December, two of nineteen members of the FOMC (Federal Open Market Committee) thought rates should go up in 2013; now it’s only one. The same number of members – five of nineteen – think rates should rise in 2014. Similarly, there were no changes in the median expected federal funds rate at the end of 2015 (1%) or the median expected long-term average for the federal funds rate (4%).
Notably, at his press conference, Fed Chairman Bernanke made it clear that the 6.5% unemployment rate will not automatically trigger higher short term rates and that much time may pass between the Fed ending its purchase of assets and finally raising rates.
This is unfortunate. Like we have said many times before, QE3 will simply add to the already enormous excess reserves in the banking system, not deal with the underlying causes of economic weakness, including the growth in government spending, excessive regulation, and expectations of higher future tax rates. QE3 will not add anything to economic growth and, as long as banks are reluctant to lend aggressively, not cause hyper-inflation either.
Nominal GDP – real GDP plus inflation – is already growing in the 3.5% to 4% range. At that pace, the economy can already sustain a much higher federal funds rate than now prevails. Maintaining rates near zero percent will eventually lead to inflation running consistently above the Fed’s 2% target, which means once it starts raising rates the peak will be higher than 4%, perhaps much higher.
This information contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Data comes from the following sources: Census Bureau, Bureau of Labor Statistics, Bureau of Economic Analysis, the Federal Reserve Board, and Haver Analytics. Data is taken from sources generally believed to be reliable but no guarantee is given to its accuracy.
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