Tuesday, March 16, 2010

The FOMC Statement And Its Key Wording

Despite growing reservations expressed recently by a number of FOMC members about the use of the expression that the "exceptionally low" interest rates will remain in effect for "an extended period" (http://www.bloomberg.com/apps/news?pid=20601068&sid=aFU6r1vdqIb8), the Committee preserved once again that key language in its statement today.


However, the clear acknowledgment in today's statement that "economic activity has continued to strengthen and that the labor market is stabilizing" raises the odds that a modification of the "extended period" expression may be in the cards for the April 27-28 meeting. By that time, the Fed will have in its possession the vast majority of the economic data for March and a firmer sense as to the forward momentum of the recovery going into the second quarter. If the balance of such evidence continues to show that economic activity is gathering steam, then the expression that has been at the hallmark of each FOMC statement since March 2009 is likely to be replaced by something like "for a while" or "for some time", a view that has been openly advocated by Kansas City Fed President Thomas Hoenig recently (and who dissented again on precisely such grounds at today's meeting).

The debate over the use of the expression "for an extended period" is actually mostly a matter of semantics and tactics, rather than substance.

In other words, the adoption of a milder language in that regard should not be viewed as meaning that the timing of the Fed tightening process will have been moved up. It will rather be a gesture giving the Fed somewhat more flexibility to make that call depending on the way the various economic data behave in the second half of the year, without feeling constrained by the unspoken promise that the current language provides. Although the Fed has never attempted to be more specific as to how long that "extended period" is actually meant to be, the assumption is that it corresponds to at least a 6- to 8-month horizon. Replacing "extended period" with "some time" does nothing by itself to precipitate the beginning of the tightening process, but it gives the Fed leeway to do so in the event that the pace of economic activity suprises with its strength by late summer, without the trepidation of breaking an "unwritten contract" with the markets.

Still, all in all, in view of the ongoing downward drift of inflation, a respectable but not exactly explosive economic recovery, and the tight credit conditions, the earliest conceivable timing of the first tightening move remains the fourth quarter of the year.

Anthony Karydakis