Wednesday’s official statement from the Federal Reserve included minimal changes from its last statement back in mid-March. The minor changes included a slightly better assessment of economic growth and more language recognizing higher headline inflation.
On the economy, the Fed said recent information “indicates that the economic recovery is proceeding at a moderate pace.” This is a slight upgrade from saying the data “suggest that the economic recovery is on a firmer footing.” In addition, the Fed said labor market conditions “are improving gradually,” an upgrade from the March language that these conditions “appear to be improving gradually.”
On inflation, the Fed prefaced its sentence about stable long-term inflation expectations and subdued underlying inflation by adding a simple declaration that “inflation has picked up in recent months.”
On the second round of quantitative easing, the Fed made it clear it will fulfill its original pledge to buy $600 billion in long-term Treasury securities by mid-year, with no plans to curtail the program early or extend it further. Going forward, the Fed will review the size and composition of the massive balance sheet it has already accumulated, suggesting that without a formal change in policy it’s committed to keeping the balance sheet steady, reinvesting the cash from maturing securities.
Otherwise, as everyone expected, the Fed made no direct changes to the stance of monetary policy, leaving the target range for the federal funds rate at 0% to 0.25%. In addition, the Fed maintained its pledge to keep the funds rate at this level for an “extended period.”
Of course, the big news Wednesday wasn’t the official statement but the fact that for the first time in history the Chairman held a press conference after the meeting. We saw two significant takeaways in that event on how the Fed will conduct monetary policy.
First, Bernanke made it clear that he views ending the reinvestment of maturing securities as a form of tightening monetary policy. As a result, we think this is likely to happen – the end of the rollover of maturing debt – before the Fed starts formally raising short-term interest rates.
Second, the Fed believes the commitment to maintain essentially zero percent short-term interest rates for an “extended period” means for at least the next couple of Fed meetings, or roughly a three month time frame. In other words, the Fed will not start raising short-term rates until at least two meetings after it removes the “extended period” language from its statement.
In our view, the economy is already in the position to handle higher short-term rates. But we are obviously not in charge. Deciphering Bernanke’s comments suggests the Fed will not start raising rates until at least 2012, perhaps much later than that. Higher inflation – and not just for commodities – will be the inevitable result.