Minutes of the Federal Open Market Committee Show Optimism on Economy and Minor Dissent on Inflation

The minutes from the Fed's January FOMC meeting show guarded optimism about the economy. But deeds say more than words, and in the end the Fed decided to stick with their statement that conditions "warrant exceptionally low levels of the federal funds rate for an extended period." This speaks in itself shows the Fed still doesn't think we are out of the woods.

Here are notes on the disussion regarding the state of the economy:

"In their discussion of the economic situation and outlook, participants agreed that the incoming data and information received from business contacts, though mixed, indicated that economic growth had strengthened in the fourth quarter, that firms were reducing payrolls at a less rapid pace, and that downside risks to the outlook for economic growth had diminished a bit further. Participants saw the economic news as broadly in line with the expectations for moderate growth and subdued inflation in 2010 that they held when the Committee met in mid-December; moreover, financial conditions were much the same, on balance, as when the FOMC last met. Accordingly, participants' views about the economic outlook had not changed appreciably. Many noted the evidence that the pace of inventory decumulation slowed quite substantially in the fourth quarter of 2009 as firms increased output to bring production into closer alignment with sales. Participants saw the slower pace of inventory reductions as a welcome indication that, in general, firms no longer had large inventory overhangs. But they observed that business contacts continued to report great reluctance to build inventories, increase payrolls, and expand capacity. Participants expected the economic recovery to continue, but most anticipated that the pickup in output and employment growth would be rather slow relative to past recoveries from deep recessions."

Moderate growth and subdued inflation are the key phrases. This led to their FOMC statement which indicated their stance on rates:

"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. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve is in the process of purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. In order to promote a smooth transition in markets, the Committee is gradually slowing the pace of these purchases, and it anticipates that these transactions will be executed by the end of the first quarter. The Committee will continue to evaluate its purchases of securities in light of the evolving economic outlook and conditions in financial markets."

Nine members of the Fed's Board of Governors voted for the statement with one dissenter - Thomas M. Hoenig. Hoenig did not vote for it because he believed the statement should be softened. After all, if conditions are improving, why not send a message to markets that rates will eventually rise. The notes state:

"Mr. Hoenig dissented because he believed it was no longer advisable to indicate that economic and financial conditions were likely to "warrant exceptionally low levels of the federal funds rate for an extended period." In recent months, economic and financial conditions improved steadily, and Mr. Hoenig was concerned that, under these improving conditions, maintaining short-term interest rates near zero for an extended period of time would lay the groundwork for future financial imbalances and risk an increase in inflation expectations. Accordingly, Mr. Hoenig believed that it would be more appropriate for the Committee to express an expectation that the federal funds rate would be low for some time--rather than exceptionally low for an extended period. Such a change in communication would provide the Committee flexibility to begin raising rates modestly. He further believed that moving to a modestly higher federal funds rate soon would lower the risks of longer-run imbalances and an increase in long-run inflation expectations, while continuing to provide needed support to the economic recovery."

I think other members of the Fed aren't concerned about inflation and feel the economy is still relatively week. Any change in the hugely accomodative policy could threaten the recovery and prematurely signal a rise in rates.

Bottom line: nothing new. The notes don't change my view of the economy or the Fed's perspective.

Bottom line: rates will stay low through the rest of 2010.

Sam Cass
Sam Cass: Sam Cass, MBA, JD, University of Texas at Austin. Always a fan of Leonardo Da Vinci.

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