- Chairman Bernanke’s second post-meeting press conference could prove more challenging than the first, given unfriendly data and the end of QE2. We do not expect major shifts in the policy message, but several tweaks seem likely in light of recent news.
- First, both the statement and the FOMC’s forecasts are likely to be more downbeat on growth. We expect the committee to revise down its 2011 GDP growth forecast to about 2.7% from 3.2% previously. Chairman Bernanke will likely mention temporary factors weighing on growth but also acknowledge a broader loss of momentum.
- Second, the committee may adjust forecasts and language on inflation slightly due to higher core readings. In particular, the statement that “measures of underlying inflation are still subdued” now looks somewhat dated. However, as in his June 7 speech, we expect the chairman to emphasize that the committee sees most of the recent pickup in inflation as transitory.
- We see no reason for the FOMC to change its tone on policy. We think the Fed is in a wide “zone of inaction”, with neither easing nor tightening likely for the time being.
Fed Chairman Bernanke chose a good moment for the central bank’s first ever post-meeting press conference. At the time of the April meeting, the Fed’s asset purchase program (“QE2”) was on auto-pilot, and incoming data had only minor implications for the outlook. His hour-long appearance moved markets very little, and was broadly viewed as a success.
His second appearance—after the two-day meeting ending tomorrow afternoon—could prove more challenging. Recent data has shown an unfriendly mix of weak growth and accelerating core inflation. Moreover, the Fed’s $600bn asset purchase program announced in November is coming to an end, and many worry about the implications for markets.
Although we do not expect major shifts in the policy message, several tweaks seem likely in light of recent news:
1. Growth slowdown not so transitory. At the last press conference, Chairman Bernanke argued that weakness in Q1 GDP growth was mostly transitory, reflecting lower defense spending, inclement winter weather, and other temporary factors. He pointed out that soft construction spending could last longer, and said that the committee saw “a bit less momentum in the economy” more broadly. But overall his message on growth was relatively positive, and the committee’s forecasts implied average GDP growth in Q2 through Q4 2011 of more than 3.5%.
Since the last meeting, weakness in growth has broadened considerably. Our Current Activity Indicator (CAI) averaged growth of just 1.6% in April and May, down from 3.6% in Q1. We now forecast GDP growth of 2% in Q2, down from 4% at the time of the last FOMC meeting. Several temporary shocks have weighed on activity—most importantly, supply chain disruptions related to the events in Japan—and growth should benefit as these fade. However, our research suggests that special factors can only explain a portion of the slowing (see for example, Sven Jari Stehn, “Weakness in Manufacturing Surveys Only Partially Due to Auto Disruption.” US Daily, June 15, 2011).
We expect that the FOMC will reflect the downshift in the data in both the statement and its forecasts. The last statement said that “the economic recovery is proceeding at a moderate pace”. In our view, the activity section could be rewritten as follows:
“Information received since the Federal Open Market Committee met in April indicates that the economic recovery has slowed in recent months, although part of the slowing appears to reflect temporary factors. Overall conditions in the labor market are improving only gradually. Household spending has grown more slowly, partly reflecting the impact of higher commodity prices on real income. Business investment continues to expand at a moderate pace, but the housing sector continues to be depressed.”
We also expect that the committee will revise down its forecast for GDP growth for this year from 3.2% at the last meeting (mid-point of the central tendency) to about 2.7% (implying second half growth of 3.5%). Chairman Bernanke will likely reiterate arguments about the temporary nature of the slowdown, but given the persistence of the weakness, he will probably also acknowledge a softer underlying trend.
2. Core inflation picking up. Core inflation has picked up further since the last meeting. The core CPI increased by 0.3% month-over-month in May, the largest gain in five years. On a year-over-year basis, the core CPI now stands at 1.5%, up from a cyclical low of just 0.6%. The turn in core PCE inflation has been less pronounced, but we forecast that it rose to 1.2% (yoy) in May, up from a low of 0.7%. We therefore think the FOMC is likely to revise up its inflation forecast slightly, by about one-tenth in both 2011 and 2012. We also see a risk that the committee could remove the phrase “measures of underlying inflation are still subdued” from the statement, which looks somewhat dated in light of recent news.
Beyond these changes, however, we expect limited concern about the broader inflation outlook. Chairman Bernanke gave detailed remarks on inflation in his June 7 speech, and we doubt a single CPI report will have shifted his views. At that time he argued “so far at least, there is not much evidence that inflation is becoming broad-based or ingrained in our economy”. He said that higher inflation mostly reflected the rise in commodity prices, which have now stabilized, and that labor cost growth has remained moderate. In addition, he said that because of stable inflation expectations, “increases in global commodity prices are unlikely to be built into domestic wage- and price-setting processes”. The bottom line in the statement should be similar to that in his latest speech: “most FOMC participants currently see the recent increase in inflation as transitory and expect inflation to remain subdued in the medium term”.
3. Policy in “zone of inaction”. The table below summarizes our expectations for changes to the FOMC’s forecasts. As discussed in the last US Economics Analyst, we believe recent changes to the growth and inflation outlook have been largely offsetting, and that the Fed’s “zone of inaction” remains wide (Sven Jari Stehn, “Sizing the Fed’s ‘Zone of Inaction’.” June 17, 2011). Neither easing nor tightening signals appear likely for the time being.
Downward Revisions to Growth, Upward Revisions to Inflation
We see no reason for the committee to change the statement’s language about policy. The statement currently says that the FOMC “will regularly review the size and composition of its securities holdings … and is prepared to adjust those holdings as needed to best foster maximum employment and price stability”. This neutral phrase remains appropriate in the current environment.
At the April press conference, Chairman Bernanke fielded several questions about further easing. To one he responded, “Going forward, we’ll have to continue to make judgments about whether additional steps are warranted. But as we do so, we have to keep in mind that we do have a dual mandate, that we do have to worry about both the rate of growth but also the inflation rate”. He added later, “The tradeoffs are getting—are getting less attractive at this point …It’s not clear that we can get substantial improvements in payrolls [from easing] without some additional inflation risk.” Balanced responses along these lines seem likely tomorrow as well.
Questions on a few other policy-related matters are likely to come up. First, is the FOMC planning to introduce an inflation target? We expect that the committee has had serious discussions, based on frequent mentions in the press and public comments from Fed officials. However, we do not believe it is ready to make changes at this time. Second, how long is an “extended period”? At the last press conference, Chairman Bernanke said that the phrase meant “there would be a couple of meetings probably before action”. If asked again, he may revise this to “at least a couple of meetings”. Third, did quantitative easing work? Weakness in growth this year has certainly raised doubts about the effectiveness of QE, but the chairman presumably will reiterate his view that it improved financial conditions and growth prospects on net.
Goldman Sachs and Co.