Fed Should Consider Strong Easing Moves

Daily Market Commentary for August 30, 2011

Federal Reserve should consider further strong easing moves with the labor market in a recession-like state.
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S&P/Case-Shiller 20-city composite released today showed U.S. home prices rose 1.1% in June from May but fell 4.5% from the last year. Compared to the first quarter, prices rose 3.6%. None of the 20 cities made new lows in June. Since the data is collected over three months, the report should be read as one for Q2. Prices advanced 3.6% in the April-through-June quarter from the January-through-March quarter. Nineteen of 20 cities saw monthly advances however; despite these positive signs, home prices are still 32% below their peaks with Cleveland in fact just moving over January 2000 levels. All California cities as well as Dallas, Denver and Washington, D.C. bottomed during 2009; Las Vegas, Miami, Phoenix, Tampa and Detroit have set new lows this year. U.S. home prices advanced 0.6% between the first and second quarters but declined 5.9% compared to the same period in 2010, the Federal Housing Finance Agency reported using home sales information from Fannie Mae and Freddie Mac acquired mortgages.

Consumer confidence plummeted during August as expectations dived, with worsening views on future business conditions, jobs and income per the Conference Board. The nonprofit organization said its consumer-confidence index fell to 44.5 in August, striking the lowest level since April 2009, from a slightly downwardly revised 59.2 in July. "A contributing factor may have been the debt ceiling discussions since the decline in confidence was well underway before the S&P downgrade," said Lynn Franco, director of the Conference Board's consumer research center, in a statement. Generally when the economy is growing at a good clip, confidence readings are at 90 and above. The expectations barometer tumbled to 51.9 during August, striking the lowest since April 2009, from 74.9 in July, while the present-situation gauge fell to 33.3 from 35.7. The 14.7-point slide in consumer confidence has only been exceeded five times: 22.6 in October 2008 after the financial panic; 18.0 in September 2005 after Hurricane Katrina; 17.0 in September 2001 after 9/11; 17.0 in August 1990 after the Iraq invasion of Kuwait and 23.0 in October 1990 after oil prices spiked.

The following are excerpts from the Aug. 9 meeting of the Federal Open Market Committee:

On the economy: “Participants noted a deterioration in labor market conditions, slower household spending, a drop in consumer and business confidence, and continued weakness in the housing sector. Manufacturing activity was reported to be mixed. Participants judged that temporary factors affecting demand and production, including the damping effect of higher energy and other commodity prices and the supply disruptions from the Japanese earthquake, could account for only some of the weakness in economic growth over the first half of the year.

While these effects appeared to be waning, the underlying strength of the economic recovery remained uncertain. In addition, many participants pointed to the recent downward revision to estimates of economic activity over the past three years, and some to the financial market strains seen during the intermeeting period, as contributing to a downgrade of the outlook for the economy. Moreover, many participants saw increased downside risks to the outlook for economic growth.”

On whether to act: “Most members agreed that the economic outlook had deteriorated by enough to warrant a Committee response at this meeting. While all felt that monetary policy could not completely address the various strains on the economy, most members thought that it could contribute importantly to better outcomes in terms of the Committee’s dual mandate of maximum employment and price stability. In particular, some members expressed the view that additional accommodation was warranted because they expected the unemployment rate to remain well above, and inflation to be at or below, levels consistent with the Committee’s mandate.

A few members felt that recent economic developments justified a more substantial move at this meeting, but they were willing to accept the stronger forward guidance as a step in the direction of additional accommodation. Three members dissented because they preferred to retain the forward guidance language employed in the June statement.”

On the pledge to keep rates low until mid-2013: “That anticipated path for the federal funds rate was viewed both as appropriate in light of most members’ outlook for the economy and as generally consistent with some prescriptions for monetary policy based on historical and model-based analysis. In choosing to phrase the outlook for policy in terms of a time horizon, members also considered conditioning the outlook for the level of the federal funds rate on explicit numerical values for the unemployment rate or the inflation rate. Some members argued that doing so would establish greater clarity regarding the Committee’s intentions and its likely reaction to future economic developments, while others raised questions about how an appropriate numerical value might be chosen.”

On what options are available: “Reinforcing the Committee’s forward guidance about the likely path of monetary policy was seen as a possible way to reduce interest rates and provide greater support to the economic expansion; a few participants emphasized that guidance focusing solely on the state of the economy would be preferable to guidance that named specific spans of time or calendar dates. Some participants noted that additional asset purchases could be used to provide more accommodation by lowering longer-term interest rates. Others suggested that increasing the average maturity of the System’s portfolio, perhaps by selling securities with relatively short remaining maturities and purchasing securities with relatively long remaining maturities, could have a similar effect on longer-term interest rates. Such an approach would not boost the size of the Federal Reserve’s balance sheet and the quantity of reserve balances. A few participants noted that a reduction in the interest rate paid on excess reserve balances could also be helpful in easing financial conditions.”

On dissents: “Mr. Fisher discussed the fragility of the U.S. economy but felt that it was chiefly nonmonetary factors, such as uncertainty about fiscal and regulatory initiatives, that were restraining domestic capital expenditures, job creation, and economic growth. He was concerned both that the Committee did not have enough information to be specific on the time interval over which it expected low rates to be maintained, and that, were it to do so, the Committee risked appearing overly responsive to the recent financial market volatility. Mr. Kocherlakota’s perspective on the policy decision was shaped by his view that in November 2010, the Committee had chosen a level of accommodation that was well calibrated for the condition of the economy. Since November, inflation had risen and unemployment had fallen, and he did not believe that providing more monetary accommodation was the appropriate response to those changes in the economy. Mr. Plosser felt that the reference to 2013 might well be misinterpreted as suggesting that monetary policy was no longer contingent on how the economic outlook evolved. Although financial markets had been volatile and incoming information on growth and employment had been weaker than anticipated, he believed the statement conveyed an excessively negative assessment of the economy and that it was premature to undertake, or be perceived to signal, further policy accommodation. He also judged that the policy step would do little to improve near-term growth prospects, given the ongoing structural adjustments and external challenges faced by the U.S. economy.”

Gold futures regained the $1,800-an-ounce mark today, surging more than 2% as investors questioned the rebound for U.S. equities and had lingering concerns about the state of the global economy.


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