FOMC Preview: QE3 vs. Forecast Extension; Economic Trends to Watch

Zero Bound Fed Funds Rate 0%
(St. Louis Fed)
Will the Fed enact QE tomorrow, stay put, or extend its forecast until the market crashes, unemployment rises, or a recession finally gets realized? Below are charts of economic trends to keep an eye on (backward looking of course). The FOMC meets again on September 12-13. Look at the Federal Funds rate since 1954. It is currently at the zero bound (0%), a level never seen before on the chart. The rate was just under 20% in the early 1980s. See a table of daily Federal Funds rate data at the New York Fed ("by trading government securities, the New York Fed affects the federal funds rate, which is the interest rate at which depository institutions lend balances to each other overnight"). 

Here are some views on what to expect in tomorrow's policy statement.
  • FOMC Preview - Rate Extension But No NEW QE (w/Goldman Sachs FOMC Preview) (Zero Hedge)
  • Twist is Fed's most effective policy tool right now (Sober Look)
  • QE3 feels near but here’s two reasons why it’s different this time (Economic Musings)
  • Fed Seen Forgoing New Bond Buying Program Until September (Bloomberg)
  • Markets Could Lose 'Quite a Few Percent' on Easing Disappointment (Sean Darby, Chief Global Equity Strategist of Jefferies in Hong Kong) (

Economic Data

The velocity of money has been rolling over for a while now, meaning the money supply has been translating into less and less GDP since 2010 (GDP/M2). I covered this in a blog post on June 6: Money Velocity Has Been Falling Since 2010 (GDP/M2, GDP/MZM). Below are long term charts of the 'Velocity of M2 Money Stock', 'Unemployment Rate', and year-over-year percent change in GDP via the St. Louis Fed. It looks like GDP's y/y percentage has been bumping up against 5% for a while. The unemployment rate has been falling, but it's still very high based on historical standards at 8.2%.

GDP Percent Change From Year Ago (St. Louis Fed)

Velocity of Money Supply (Source: St. Louis Fed)

Unemployment Rate (St. Louis Fed)

Here are details from the FOMC's previous policy meeting on June 19-20 via the FOMC Minutes release.

"Committee Policy Action
Committee members saw the information received over the intermeeting period as suggesting that the economy had been expanding moderately. However, growth in employment had slowed in recent months, and almost all members saw the unemployment rate as still elevated relative to levels that they viewed as consistent with the Committee's mandate. Members generally expected growth to be moderate over coming quarters and then to pick up very gradually, with the unemployment rate declining only slowly. Most projected somewhat slower growth through next year, and a smaller reduction in unemployment, than they had projected in April. Furthermore, strains in global financial markets, which largely stemmed from the sovereign debt and banking situation in Europe, had increased during the intermeeting period and continued to pose significant downside risks to economic activity both here and abroad, making the outlook quite uncertain. The possibility that U.S. fiscal policy would be more contractionary than anticipated was also cited as a downside risk. Inflation had slowed, mainly reflecting the decline in the prices of crude oil and gasoline in recent months. Averaging through its recent fluctuations, inflation appeared to be running near the Committee's 2 percent longer-run objective; with longer-term inflation expectations stable, members anticipated that inflation over the medium run would be at or below that rate. Some members judged that persistent slack in resource utilization posed downside risks to the outlook for inflation. In contrast, one member thought that maintaining the current highly accommodative stance of monetary policy well into 2014 would pose upside risks to inflation.

In their discussion of monetary policy for the period ahead, members agreed that it would be appropriate to keep the target range for the federal funds rate at 0 to 1/4 percent in order to support a stronger economic recovery and to help ensure that inflation, over time, is at the 2 percent rate that the Committee judges most consistent with its mandate. In addition, all members but one agreed that it would be appropriate to continue through the end of this year the Committee's program to extend the average maturity of the Federal Reserve's holdings of securities; specifically, they agreed to continue purchasing Treasury securities with remaining maturities of 6 years to 30 years at the current pace of about $44 billion per month while selling or redeeming an equal amount of Treasury securities with remaining maturities of approximately 3 years or less. These steps would increase the Federal Reserve's holdings of longer-term Treasury securities by about $267 billion while reducing its holdings of shorter-term Treasury securities by the same amount. Members also agreed to maintain the Committee's existing policy regarding the reinvestment of principal payments from Federal Reserve holdings of agency securities into agency MBS. Members generally judged that continuing the maturity extension program would put some downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. Some members noted the risk that continued purchases of longer-term Treasury securities could, at some point, lead to deterioration in the functioning of the Treasury securities market that could undermine the intended effects of the policy. However, members generally agreed that such risks seemed low at present, and were outweighed by the expected benefits of the action. Several members noted that the downward pressure on longer-term rates from continuing the Committee's maturity extension program was likely to be modest. One member anticipated little if any effect on economic growth and unemployment and did not agree that the outlook for economic activity and inflation called for further policy accommodation.

With respect to the statement to be released following the meeting, members agreed that only relatively small modifications to the first two paragraphs were needed to reflect the incoming economic data and the changes to the economic outlook. In light of their assessment of the economic situation, almost all members again agreed to indicate that the Committee expects to maintain a highly accommodative stance for monetary policy and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014. Some Committee members indicated that their policy judgment reflected in part their perception of significant downside risks to growth, especially since the Committee's ability to respond to weaker-than-expected economic conditions would be somewhat limited by the constraint imposed on monetary policy when the policy rate is at or near its effective lower bound. Members again noted that the forward guidance is conditional on economic developments and that the date given in the statement would be subject to revision should there be a significant change in the economic outlook.

A few members expressed the view that further policy stimulus likely would be necessary to promote satisfactory growth in employment and to ensure that the inflation rate would be at the Committee's goal. Several others noted that additional policy action could be warranted if the economic recovery were to lose momentum, if the downside risks to the forecast became sufficiently pronounced, or if inflation seemed likely to run persistently below the Committee's longer-run objective. The Committee agreed that it was prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability. A few members observed that it would be helpful to have a better understanding of how large the Federal Reserve's asset purchases would have to be to cause a meaningful deterioration in securities market functioning, and of the potential costs of such deterioration for the economy as a whole."

And what is going on here? When do we put the mortgage market on exchanges for better market transparency and efficiency? The Fed is being too transparent in its agency paper purchases (Sober Look).

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