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Fed Brief

Jul 30 2014 - FOMC Starts Walking a Fine Line

The FOMC policy directive from the July meeting wasn't a carbon copy of the June directive.  It was close to it, yet there were some important nuances that suggested to us the Fed is slowly introducing some transitional language to make participants aware that an earlier than expected rate hike isn't out of the question.

In particular, we would note the July directive now acknowledges that "the likelihood of inflation running persistently below 2 percent has diminished somewhat" versus the language in the prior directive which said, "The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance."

Price stability of course is one side of the Fed's dual mandate.  On that side, then, we'd argue that the inflation commentary is starting to tilt to the hawkish side of things.

The other side of the mandate is maximum employment, and on that front the Fed continues to be quite dovish.  To that end, the FOMC made a point of highlighting that, "a range of labor market indicators suggests that there remains significant underutilization of labor resources."

In considering the July directive, it had an element of laying some foundation for justifying the timing of the first hike in the fed funds rate in accordance with the market's consensus view (i.e. latter half of 2015) or perhaps moving up the timing of a first rate hike.

We would add, too, that the directive did not have unanimous support.

Philadelphia Fed President Plosser dissented, citing his objection to the guidance indicating that it will likely be appropriate to maintain the current target range for the federal funds rate for "a considerable time after the asset purchase program ends," because such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee's goals.

That was the first dissent since Fed Chair Yellen starting steering the FOMC meetings.

As expected, the FOMC agreed to cut its pace of agency mortgage-backed securities purchases to $10 bln per month (from $15 bln) and its purchases of longer-term Treasury securities to $15 bln per month (from $20 bln).

With the tilt to a slightly more hawkish stance on inflation trends, incoming employment data that is stronger than expected should have a more meaningful impact on the market's behavior than weaker than expected inflation data would.  That's because the market is already accepting of the idea that the fed funds rate will stay lower for longer.  Stronger than expected employment data, therefore, would challenge that thinking since market participants are cognizant that employment growth and labor growth are lagging indicators.

The Fed itself is cognizant that it is walking a fine line right now trying to manage the market's rate hike expectations and the July directive suggests as much.

--Patrick J. O'Hare,

Fed Economic Projections (central tendencies as of  June 2014)
  2014 2015 2016 Long Run
Change in real GDP 2.1 to 2.3     3.0 to 3.2     2.5 to 3.0     2.1 to 2.3
March projection 2.8 to 3.0     3.0 to 3.2     2.5 to 3.0     2.2 to 2.3
Unemployment rate 6.0 to 6.1     5.4 to 5.7     5.1 to 5.5     5.2 to 5.5
March projection 6.1 to 6.3     5.6 to 5.9     5.2 to 5.6     5.2 to 5.6
PCE inflation 1.5 to 1.7     1.5 to 2.0     1.6 to 2.0     2.0
March projection 1.5 to 1.6     1.5 to 2.0     1.7 to 2.0     2.0
Core PCE inflation 1.5 to 1.6     1.6 to 2.0     1.7 to 2.0     --
March projection 1.4 to 1.6     1.7 to 2.0     1.8 to 2.0     --
Source: Federal Reserve

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