US Fed Modestly Revises Down Growth Outlook

The minutes of the June 22-23, 2010 Federal Open Market Committee (FOMC) meeting provided the details of the discussions on the economic outlook and prospective changes to policy. In all, the minutes highlight that the Fed is seeing some greater downside risks to growth, although the committee members were generally of the view that the recovery will continue. The increased downside risks reflected some deterioration in financial markets and attendant rise in the cost of capital in the wake of rising fiscal strains facing some European countries.  The range for GDP growth in 2010 (on a fourth quarter-over-fourth quarter basis) was lowered to 3.0% - 3.5% from 3.2% - 3.7% in April. Growth in 2011 and 2012 was projected to rise in a range of 3.5% - 4.2% and 3.5% - 4.5%, respectively. The forecast update also included an attendant upward revision to the range for the unemployment rate this year to 9.2% - 9.5% from 9.1% - 9.5% previously.  The unemployment rate is still expected to trend lower during 2011 and 2012, although at a slightly slower pace than previously projected with the 2012 range raised to 7.1% - 7.5% compared to the 6.6% - 7.5% range expected in April.  Inflation forecasts were trimmed back once again, with the headline PCE rate forecasted at 1.0% - 1.1% (was 1.2% - 1.5% in April) and the core PCE deflator expected to be in a 0.8% - 1.0% (was 0.9%-1.2%) range in 2010. Inflation is generally projected to drift up slowing in the next two years to a range in 2012 of 1.0% - 1.7% for the headline PCE and 1.0% - 1.5% for core PCE.

While the risks to growth have shifted to the downside, the risks to inflation were felt to be more balanced, albeit around very low rates of increase indicated above. With that said, some members expressed concern about an even weaker rate with the possibility of deflation emerging; however, this sentiment was countered by others who thought that “inflation was unlikely to fall appreciably further given the stability of inflation expectations in recent years and very accommodative monetary policy.”

With respect to policy, the dominant view was that the changes to the outlook “were viewed as relatively modest and as not warranting policy accommodation beyond that already in place.” The minutes noted the need both to test instruments to withdraw the stimulus added during the recession and to consider policy options if “the outlook were to worsen appreciably.”

Regarding the Fed’s balance sheet, the discussion was largely limited to the sales of assets. Participants agreed that gradual sales of assets should be undertaken in an effort to normalize the Fed's balance sheet, but no agreement has been reached as to when this should occur. A majority felt that it is appropriate to defer asset sales for some time, with some noting the modest weakening in the economic outlook since the last meeting as an additional reason to do so. Moreover, the majority continued to anticipate that asset sales would start after the committee had begun to firm policy by increasing short-term interest rates, postponing sales until the economic recovery was well established and maintaining short-term interest rates as the Fed's key monetary policy tool. It was agreed that it is important to maintain flexibility in terms of timing and pace of sales, given the uncertainties of market reactions of this size and scope of the asset sales. It, also, emphasized that any decision to sell assets would need to be communicated to markets well in advance of the initiation of such transactions, and "that sales should be conducted at a gradual pace and potentially be adjusted in response to developments in economic and financial conditions."

Information contained in this report has been prepared by the Economics Department of RBC Financial Group based on information obtained from sources considered to be reliable. While every effort has been made to ensure accuracy and completeness, RBC Financial Group makes no such representation or warranty, express or implied. This report is for information purposes only and does not constitute an offer to sell or a solicitation to buy securities.