FOMC Leaves Policy Unchanged

The FOMC concluded their two-day meeting by holding policy constant, as expected.  The assessment of the economy was largely unchanged.  From March:

Information received since the Federal Open Market Committee met in January suggests a return to moderate economic growth following a pause late last year.  Labor market conditions have shown signs of improvement in recent months but the unemployment rate remains elevated.  Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy has become somewhat more restrictive.  Inflation has been running somewhat below the Committee’s longer-run objective, apart from temporary variations that largely reflect fluctuations in energy prices.  Longer-term inflation expectations have remained stable.

Now:

Information received since the Federal Open Market Committee met in March suggests that economic activity has been expanding at a moderate pace. Labor market conditions have shown some improvement in recent months, on balance, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy is restraining economic growth. Inflation has been running somewhat below the Committee’s longer-run objective, apart from temporary variations that largely reflect fluctuations in energy prices. Longer-term inflation expectations have remained stable.

Notably, recent data has had little impact on the Fed’s economic outlook.  This includes the last employment report as well.  The inclusion of the term “on balance” was clearly intended to downplay the March numbers.

My interpretation is that the Fed is attempting to move away from being pulled this way and that by the monthly fluctuations of the data and instead focus on the underlying trend; presumably, it is that trend that should be guiding policy decisions. Of course, one could argue that that underlying trend should induce them to additional action, but that is neither here nor there at this point.  From their perspective, policy is appropriate given that trend. The Fed also strengthened its language on fiscal policy, but again the damage so far is not sufficient to change the course of policy.  Or, probably more accurately, the damage is not so great that the Fed is willing to let Congress hit the ball into their court.

The other significant change came latter in the statement.  From March:

The Committee will closely monitor incoming information on economic and financial developments in coming months.  The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.  In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.

Now:

The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.

In the wake of the last meeting, comments from some Fed presidents as well as the minutes themselves seemed to imply that further expansion of the large scale asset purchase program was out of the question.  Instead, it seemed the focus had firmly shifted to ending QE as soon as possible, with the end of this year as a goal.  With this language shift, the FOMC pulls back on this direction, and instead makes it clear than an expansion of the program is still possible.  And possible not only due to a changing employment outlook, but also due to a deteriorating inflation picture.

But isn’t the inflation picture already deteriorating?  Yes, the latest numbers suggest a worsening disinflation trend.  The Fed, however, probably has not adjusted their forecast; they probably do not expect that substantially lower inflation is likely given that inflation expectations remain anchored and economic activity is not deteriorating.   In such an environment, they likely are not all that concerned that inflation is running somewhat below target.

Moreover, the Fed has that cost-benefit analysis thing working in the background, and likely believes that any more than $85 billion a month is not likely to have large, positive marginal benefits.  Not enough to justify expanding policy further for any small changes to the forecast.

Bottom Line:  The urge to taper off quantitative easing has lessened since the last meeting. That pushes the beginning of the end back to the later back of the year.  The door is open to additional stimulus as well, but I suspect that it would have to be driven by the employment side of the mandate.  Clear evidence of a deflationary threat is likely necessary to drive action on the other side of the mandate; such a threat seems unlikely in an expanding economy.