Just a Few Weeks Makes a World of Difference, by Tim Duy: The minutes of the last FOMC meeting, concluded on March 20, included this passage:
In light of the current review of benefits and costs, one member judged that the pace of purchases should ideally be slowed immediately. A few members felt that the risks and costs of purchases, along with the improved outlook since last fall, would likely make a reduction in the pace of purchases appropriate around midyear, with purchases ending later this year. Several others thought that if the outlook for labor market conditions improved as anticipated, it would probably be appropriate to slow purchases later in the year and to stop them by year-end. Two members indicated that purchases might well continue at the current pace at least through the end of the year.
The center of the FOMC appeared to be shifting toward agreement that large scale asset purchase program would likely be wrapped up by year end. Of course, they included a caveat:
It was also noted that were the outlook to deteriorate, the pace of purchases could be increased.
Since the last FOMC meeting, it has become clear that the economy continues along a suboptimal path, as illustrated by the disappointing 2.5 percent GDP growth for the first quarter; just a few weeks ago, Macroeconomic Advisors was anticipating a 3.6 percent growth rate. In addition, both employment and manufacturing reports have been less than impressive (see Calculated Risk for his take on today's Dallas Fed numbers and the implications for the ISM report). Moreover, fiscal austerity continues to bite:
The end result is that investors have concluded, rightly, that FOMC members looking forward to cutting the pace of purchases by mid-year were overly optimistic. Consequently, the 10-year yield was bid down to just 1.67 percent this afternoon, well below the 2.05 in early March.
Probably more important, at this juncture is that disinflation is again evident, with headline and core PCE up just 1.0 and 1.1 percent, respectively, compared to last year:
In an April 17 Wall Street Journal interview, St. Louis Federal Reserve President James Bullard highlighted the possibility that a deteriorating inflation trend might require additional easing. Other policymakers have joined him in this concern. From Bloomberg:
“I’d of course be giving serious thought” to additional stimulus if disinflation persists, Richmond Fed President Jeffrey Lacker, who voted against the bond program last year, said last week -- while adding he doesn’t think that will happen. The Minneapolis Fed’s Narayana Kocherlakota also said this month weaker inflation may be reason to consider more accommodation.
The important point is that low inflation prompts concern even among policymakers who think the Fed can have little impact on employment growth. For this group, high unemployment is distressing but not actionable. But low inflation is both distressing and actionable. Thus, at a minimum, the low inflation numbers should push the FOMC back to avoiding a premature end to quantitative easing. In addition, it is easy to argue that the Fed should be thinking about additional easing. Not only are they missing on the employment mandate, but increasingly it looks like they are missing on the price stability mandate as well. A policy failure all around.
Bottom Line: The FOMC statement should shift to indicate the softer economy and falling inflation numbers; I am watching for how much emphasis they place on the latter as a signal as to the likelihood of easing further in future meetings. Like most, I don't anticipate an expansion of the program at this juncture. I doubt the FOMC would see the current data as justifying a leap from thinking about ending the program to expanding the program just six weeks later. It would be interesting if Kansas City Federal Reserve President Esther George pulls her dissent. Her objection has been that the Fed's policy stance risks financial stability for little economic benefit. Pulling her dissent in response to falling inflation would signal that disinflation concerns run deep in the FOMC.