Some Thoughts on the Fed Minutes

The Fed released its minutes a few hours ago. These are the most predictable minutes that I can remember. To no one's surprise the Fed kept the Fed Funds Rate at its current levels. Also to no one's surprise, the Fed analyzed the current state of the economy as bottoming out and steadying.

Information received since the Federal Open Market Committee met in August suggests that economic activity has picked up following its severe downturn. Conditions in financial markets have improved further, and activity in the housing sector has increased. Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.

If you are looking at a graph of an economic cycle, we are at the bottom and, according to the Fed, at the beginning of the upswing.

The most important question going forward is just how quickly will we recover. Will we see unemployment below five percent in the next year or year and half? Or, is it more likely that growth and unemployment will stagnate and the economy will grow slowly and keep unemployment fairly high for years?

The Federal Reserve outlook seems to be closer to the second scenario than the first. The markets initially reacted positively. At one point the Dow pushed above 9900 and the Dow was up nearly one percent. Yet, in the last hour and a half the Dow lost everything and another 81 points. Meanwhile, the ten year U.S. Treasury bond pushed down to 3.41% after being as high as 3.49% during the day. This may have something to do with the outlook of the Fed of upcoming inflation.

With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.

Often the initial reaction to Fed minutes is indicative of little long term and so I would caution anyone with reading too much into any of this.

Finally, the Federal Reserve said it would " continue to employ a wide range of tools to promote economic recovery and to preserve price stability". The Fed continues.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt. The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010. As previously announced, the Federal Reserve’s purchases of $300 billion of Treasury securities will be completed by the end of October 2009. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

So, while I wouldn't expect the sort of loose money policy that we saw over the last twelve months, we should expect loose monetary policy for the indefinite future.