U.S. FOMC Holds Fed Funds Steady and Reduces Monthly Asset Purchases
by a Further $10 Billion
The Federal Open Market Committee (FOMC) met expectations and cut a further $10 billion from the pace of monthly asset purchases. Beginning in August 2014, the Fed will purchase $10 billion of agency mortgage-backed securities (MBS) and $15 billion of longer-term Treasuries per month, which will be down from $15 billion and $20 billion, respectively. No change was made to the fed funds target range of 0.00% to 0.25%. The most significant difference in today’s statement was the Fed’s acknowledgement that the downside risk to the inflation outlook “has diminished somewhat.”
The Fed also maintained its forward guidance that the fed funds rate will likely be held in its current range “for a considerable time after the asset purchase program ends.” Voting member, Charles Plosser, objected to reiterating this statement as he deemed it to be “time dependent” and not taking into account the “considerable economic progress” that has been made toward the Fed meeting its goals. The statement noted again that economic conditions may warrant keeping the fed funds target “below levels the Committee views as normal in the long run,” even after the employment and inflation have reached “mandate-consistent levels.”
The statement noted that economic activity “rebounded in the second quarter” and that consumer spending and business investment continue to advance, while growth in the housing sector “remains slow.” This assessment was borne out in today’s advanced report on second-quarter 2014 real gross domestic product (GDP) growth that showed the economy grew at a 4.0% annualized pace following a revised 2.1% annualized decline in the first quarter that was previously reported as -2.9%. The report showed that consumption added 1.7 percentage points to the growth rate, and non-residential investment provided a 0.7 percentage point lift. Residential investment added 0.2 percentage points, which was just enough to reverse the 0.2 percentage point drag in the first quarter.
The statement acknowledged the improvement in labour market conditions including the decline in the unemployment rate, which was the lowest since October 2008 as of June at 6.1%. Still, policymakers concluded that a wider range of labour market indicators show that “there remains significant underutilization of labour resources.” On inflation, the FOMC statement made a nod to the recent increase in inflation by stating that the rate was “somewhat closer to the Committee’s longer-run objective” and acknowledged that “the likelihood of inflation running persistently below 2% has diminished somewhat.” The core personal consumption expenditure (PCE) deflator was 1.5% higher than a year earlier in the second quarter, thereby marking acceleration following four consecutive quarters when the inflation rate averaged 1.3% although still below the Fed’s 2.0% target.
With the economy largely performing in line with the Fed’s expectations, today’s decisions to stay the course, to continue to unwind the quantitative easing (QE) program, and to maintain the Fed funds target range were not surprising. Even with the economy rebounding sharply in the second quarter and early July indicators suggesting that the momentum was maintained, labour market slack exists that is stifling wage growth and in turn keeping inflation below the Fed’s mandated level. The strengthening in the economy argues for the Fed to continue to retract the quantitative easing program, but the persistence of excess capacity supports the Fed’s stance that it is appropriate for official rates to remain highly stimulative. Our forecast assumes that the Fed will announce the end of the QE program at the October 2014 FOMC meeting and maintain the fed funds rate in its current range until the second half of 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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