Fed Talk

For every meeting from now till the economic data shows significant upside, the FOMC will be facing the same question. Do we act now? Do we hold off?

The next meeting is due on September 21, 2010 and the Fed is most likely going to be inclined to wait. One suspects that the tone of the Fed would become slightly dimmer. But the likelihood of it embarking on a new round of quantitative easing as was hinted by Bernanke in his speech at Jackson Hole, seems dim. Even with dismal Home sale numbers and revised Q2 GDP of 1.6% (from 2.4% previously), the hurdle required for Bernanke to make such a move is absent.

There has been little to suggest a significant deterioration since then: private sector payrolls rose by 67,000 in August and manufacturers made positive noises in the most recent Institute of Supply Management survey. Given the Jackson Hole signal, to make a big move in September would risk confusion in the markets.

There is also a strong suspicion that the latest growth number overstates the weakness of the economy. An apparent surge in oil imports alone subtracted more than one percentage point from growth in the second quarter in spite of little sign that the US was actually consuming more oil.

It does not follow, however, that the FOMC will continue to sit on its hands as long as the data do not get any worse. The committee’s outlook is that growth will accelerate to 3 or 4 per cent in 2011 – well above its long-run trend. Any sign that the economy is not speeding up again in the coming months would be a “significant deterioration” to many FOMC members, prompting action.

A reason to act immediately would be a further loss of market confidence in the outlook for growth and inflation but Mr Bernanke’s Jackson Hole speech seems to have had a soothing effect.

There is one other argument in favour of a September move, although Fed officials insist that it is irrelevant. The Fed’s subsequent meeting ends on November 3 – the day after midterm elections in which the Democrats might lose control of Capitol Hill – and it could be politically uncomfortable to make a big change to monetary policy the next day.

If and when the Fed does decide to ease policy, there is a fairly strong consensus on the FOMC that further quantitative easing is the way to do it.

Some form of “QE2” is likely to be one of the policy options put to the September meeting and the committee may debate the form it would take were it needed.