The rate-setting committee of the Federal Reserve is starting off the year with a bang. No change to rates is expected Wednesday, but the Federal Open Market Committee will unveil a new strategy for communicating monetary policy.
The new forward guidance will come in the form of a component to the Fed’s “summary of economic projections” and will forecast the path of the federal funds rate.
The addition will include committee members’ projections for the timing of a rate increase and some predictions about the size of the Fed’s balance sheet.
An abbreviated version of the summary of economic projections will accompany the FOMC’s statement following its meeting Wednesday. (The full version will be released with the minutes of the meeting three weeks hence.) Wednesday is noteworthy for another reason: It marks the first news conference of the year by Ben Bernanke, chairman of the Federal Reserve.
Though the federal funds rate will remain at the current level, a relative wave of information about rates is anticipated.
“They’re trying to explain their goals and what they think is optimal monetary policy, so they are adding a few things: a forecast for the fed funds rate, a prediction for the optimal timing of that first rate hike and the optimal size of the balance sheet given the economic conditions that they are projecting,” says Paul Edelstein, director of financial economics at IHS Global Insight, an economic forecasting and analysis company.
The information should telegraph the intentions of the rate-setting committee and dissipate uncertainty in financial markets.
Questions about QE3 persist
Last fall at the September meeting, the Fed took the unprecedented step of stating that the federal funds rate would remain at the current level, between zero percent and 0.25 percent, until mid-2013.
In an effort to goose the economy, the Fed embarked on two huge bond-buying programs, colloquially known as QE1 and QE2, for the successive rounds of quantitative easing. QE2 wrapped up at the end of June last year.
A third bond-buying program, Operation Twist, is underway and scheduled to end in June. The program extends the maturity of the Fed’s portfolio rather than adding to it.
Appetites for expanding the Fed’s portfolio could be growing, however. Current speculation says that a third round of stimulus could be in the cards — this time aimed primarily at mortgage-backed securities.
Though economic data have been leaning into positive territory, some experts expect growth to flounder in 2012.
Many Fed members “are still disappointed in the pace of the recovery and think that the unemployment rate is still too high and inflation is too low, so that gives them a little wiggle room to stimulate some more,” says Edelstein.
“Some of the better growth that we’ve been seeing recently is probably going to tail off in 2012, and we’ll be left with growth closer to 2 percent quarter over quarter, which is not remarkable. A lot of the Fed’s predictions are still above that. So that could be some disappointment,” he says.
New year, new voices
A change in the composition of the committee introduces a new wrinkle into the debate over quantitative easing.
The five members of the Board of Governors, plus the president of the Federal Reserve Bank of New York, are permanent voting members of the committee. There are two empty seats on the board. President Barack Obama has nominated two candidates, though they have not been confirmed by the Senate.
The four remaining seats are rotated among 11 Reserve Bank presidents for one-year terms. As a result, Charles Evans from Chicago, Richard Fisher from Dallas, Narayana Kocherlakota from Minneapolis and Charles Plosser from Philadelphia are out. In their places are Jeffrey Lacker from Richmond, Va., Dennis Lockhart from Atlanta, Sandra Pianalto from Cleveland and John Williams from the San Francisco Federal Reserve Bank.
The outgoing Fisher, Kocherlakota and Plosser are regarded as inflation hawks. The incoming Lockhart, Pianalto and Williams are considered inflation doves. The balance of power could shift toward the doves, who take a softer view of inflation and have shown more enthusiasm for stimulus.
“Coming in are at least two doves, possibly three. They think the balance of risks is weighed more toward recession, so there could be more support for (QE3),” Edelstein says.
The central bank is unlikely to pull a surprise QE out of its hat. For at least this meeting, the attitude is expected to be one of wait and see.
As in past statements, the committee will likely “reserve the right to look at further stimulus. But I would be surprised if they went that route. I think they will go back to managing with smaller movements,” says Daniel Penrod, senior industry analyst with the California Credit Union League.
Europe and everything else
One of the wild cards in the mix remains the European debt crisis. While there is no political will for bailing out eurozone countries, the central bank has promised to prevent fallout from harming the American banking system.
“The Fed has made commitments with their currency swaps to the European banks, and I think they are probably monitoring that situation closely to see if things are stabilizing and what that means for our economy,” says Gary Thayer, chief macro strategist with Wells Fargo Advisors.
“It’s clearly not having as big an impact as a lot of people feared it would, but it’s still a significant head wind,” he says.
As if that’s not enough change and tumult for the FOMC to wrestle into submission, the committee could continue to explore setting a specific inflation target. That could be revealed at the news conference or three weeks later in the minutes from the meeting.
The most salient Fed news from January will be the revelations contained in the new forward guidance and any breadcrumbs dropped by Chairman Bernanke at the news conference.