U.S. FOMC Makes No Changes to Policy in March

• The Federal Market Open Market Committee (FOMC) made no changes to monetary policy at its March meeting.
• The pace of balance sheet expansion at $40 billion per month for agency mortgage-backed securities (MBS) and $45 billion per month for longer-term treasuries was retained.
• The fed funds rate target remains in the 0% to 0.25% range, which is a level that is still anticipated to be “appropriate at least as long as the unemployment rate remains above 6.5%” and inflation during the next year or two is expected “to be no more than a half percentage point above the Committee’s 2% longer-run goal.”
• The FOMC’s growth forecast for 2013 was revised downward slightly to 2.3% to 2.8% range while an expected unemployment rate of 6.0% to 6.5% in late 2015 supports the Committee’s majority view that policy firming will not be appropriate until 2015.
• A slightly improved assessment of current economic conditions was offset by concerns about coming greater than expected fiscal contraction to leave the Fed’s characterization of the economic outlook little changed in the March policy statement. As a result, today’s statement provided little if any indication that the Fed is close to pulling back on its current highly stimulative monetary policy stance. With labour market slack continuing to keep a lid on underlying inflation pressures, we expect the Fed to continue security purchases until the end of this year. The fed funds rate is likely to be maintained at its current “exceptionally low range” of 0.00% to 0.25% into 2015.

As expected, the FOMC made no changes to monetary policy or its forward guidance on interest rates at this month’s policy meeting. The target for the federal funds rate, as universally expected, remains in the 0.0% to 0.25% range, which is a level that is still anticipated to be “appropriate at least as long as the unemployment rate remains above 6.5%” and the outlook for inflation remains “no more than a half percentage point” above the Committee’s 2% longer-run goal. Asset purchases were maintained at a monthly pace of $40 billion for agency MBS and $45 billion for longer-term treasures with principal payments continuing to be reinvested.

The FOMC made slight changes to its assessment of economic conditions although, on balance, the characterization of the outlook was little changed. The Committee noted that the economy returned to “moderate economic growth,” thereby supporting the Fed’s earlier assessment in the January 30, 2013 policy statement that a “pause” in activity late in 2012 largely reflected “weather-related disruptions and other transitory factors” rather than underlying weakness. Labour markets are noted to have “shown signs of improvement in recent months,” which was a nod to stronger than expected employment gains, on average, in January and February, but “the unemployment rate remains elevated.” As well, housing markets have “strengthened further,” and household and business spending continued to advance.

Providing offset to the arguably more upbeat characterization of the current economic backdrop, however, are concerns about the effect of larger than expected cuts in government spending this year, therein reflecting the failure of political forces to avoid so called sequestration cuts in early March. The statement noted that “fiscal policy has become somewhat more restrictive.”

On balance, the greater than anticipated fiscal contraction was enough to outweigh better current conditions and resulted in an, albeit slight, downward revision to growth forecasts in the accompanying release of the Committee’s Summary of Economic Projections. The central tendency forecast for 2013 real GDP growth was lowered slightly to a 2.3% to 2.8% range from 2.3% to 3.0% in December 2012 (central tendency forecasts exclude the three highest and lowest projections). In both 2014 and 2015, the growth forecasts were lowered modestly; however, the projections still show a gradual acceleration in the pace of growth during the three-year period to a 2.9% to 3.4% range in 2014 (from 3.0% to 3.5% in December) and to 2.9% to 3.7% in 2015 (from 3.0% to 3.7%).

Despite the downward revision to GDP growth, the forecasted range for the unemployment rate for the fourth quarter of 2013 was lowered to a 7.3% to 7.5% range from 7.4% to 7.7% in December. This likely reflected the February unemployment rate dropping to a lower than expected 7.7% rate. As well, the Fed revised its forecasts downward for the fourth quarter of 2014 (to 6.7% to 7.0% from 6.8% to 7.3%) and the fourth quarter of 2015 (to 6.0% to 6.5% from 6.0% to 6.6%), while maintaining its estimate of the full-employment rate at 5.2% to 6.0%. Near-term inflation projections were also revised downwardly from those seen in December, with the range for overall Personal Consumption Expenditure (PCE) inflation changed to a 1.3% to 1.7% range for 2013 from 1.3% to 2.0%, while core PCE inflation was revised to 1.5% to 1.6% from 1.6% to 1.9% in December.

The overview of FOMC participants’ assessments of appropriate monetary policy showed a broadly unchanged dispersion of the fed funds rate forecasts from the previous release in December. For 2013, one member expects a rate increase by the end of the year (down from two in December). Of the 18 remaining participants, four expect rates to be higher in 2014 (up from three in December), while 13 expect policy firming will begin in 2015, and one member expects the first rate increase will come in 2016 (both unchanged from December). The majority consensus for policy firming to begin in 2015 is consistent with the 6.0% to 6.5% unemployment rate anticipated in the fourth quarter of 2015.

With a stronger current economic backdrop and concerns about the pace of fiscal contraction largely appearing to offset each other to leave the characterization of the economic outlook little changed, today’s statement provided little indication that the Fed is seriously thinking about shifting its monetary policy stance in the near term. Like the Fed, we expect that the pace of growth in the US economy in the current quarter will improve on the negligible 0.1% (annualized) gain in the fourth quarter; however, fiscal headwinds will provide a near-term drag on growth in mid-2013 and even an acceleration in activity in the second half of this year and in 2014 will likely not be sufficient to bring the unemployment rate below the Fed’s 6.5% threshold in either this year or next. With labour market slack continuing to keep a lid on underlying inflation pressures, we expect the Fed to continue security purchases to the end of this year. The fed funds rate is likely to be maintained at its current “exceptionally low range” of 0.00% to 0.25% into 2015.

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.

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