Most analysts see the minutes of the July 31-August 1 FOMC meeting as indicating a third round of asset purchases beginning in September, but I am less certain. The Committee has moved toward a dovish consensus, but this does not mean they are ready to act or that action would necessarily be in the form of quantitative easing.
Given the current hawk-dove makeup of the FOMC, it is no surprise that 11 of the 12 members reached consensus to maintain policy and potentially pursue easing in the future when they met on August 1. It is also no surprise that Mr. Lacker dissented. Moreover, the minutes plainly state:
Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.
The code "many members" rather than "most members" likely indicates that more than just Mr. Lacker disagreed. This means that Mr. Lockhart and possibly Mr. Powell may also oppose additional easing if that is on the table in the near future. But, given that "…participants saw substantial slack in resource utilization and hence continued to judge that inflation was likely to remain subdued over the medium term…" they may be more willing to side with stimulus. Regardless, Chairman Bernanke seems to have the votes if he wishes to pursue further easing.
As explained in the minutes, the Fed has three main easing options before them:
- Adjust the forward guidance.
- A third round of quantitative easing.
- A program to stimulate lending.
The first option is the least politically risky, but it is also the least stimulative. Adjusting the forward guidance longer is intended to signal markets that low rates will be available further into the future. However, as I have pointed out, extending forward guidance beyond the end of Bernanke's term, when we know that one of the Presidential candidates would not reappoint him, is not a credible signal. The other idea the Committee discussed is to adjust forward guidance to be dependent upon economic conditions. This is a more credible strategy, but since the recovery has been erratic, it may not provide the stable signal that FOMC members desire.
The second option is a third round of large scale asset purchases known as QE. This is the favored policy choice of many investors and media commentators, but some hawks have noted that further increases to the Fed balance sheet could disrupt market function and make unwinding stimulus even more challenging. The Fed staff analysis disagrees with this conclusion and indicates "…substantial capacity for additional purchases without disrupting market functioning." However, FOMC members indicated that they are not ready to write a blank check or lock themselves into a particular policy path. The minutes clearly state that any upcoming round of QE "…should be sufficiently flexible to allow adjustments, as needed, in response to economic developments or to changes in the Committee's assessment of the efficacy and costs of the program." This likely indicates a step by step program that is split between Treasury purchases and MBS purchases.
The third stimulative option at the Fed's disposal is a policy to spur lending. I have recently advocated that such a policy makes sense because it prompts businesses to utilize the cash already in the market rather than providing additional capital for them to hoard. The goal would be to increase the velocity of money, rather than increasing the monetary base. As noted in the Minutes, the Fed could go about this a couple different ways:
- They could reduce the interest rate paid on required and excess reserve balances.
- They could create a program that mirrors the British Funding for Lending scheme.
The Minutes clearly note that although "a couple of participants favored such a reduction (in interest rates), several others raised concerns about possible adverse effects on money markets." Similarly, "a couple of participants expressed interest in exploring possible programs (like Funding for Lending) aimed at encouraging bank lending to households and firms." These statements indicate that Fed officials are closely monitoring both the ECB move to reduce interest paid on reserves and the Bank of England's Funding for Lending program. While there are obvious institutional differences between these three central banks that would complicate any Fed policy to stimulate lending, this monitoring hints that the Fed might attempt to stimulate lending in the near future.
For those of us investors watching and waiting to see what the Fed does in this policy-driven economy, it is important to note that we are not just paying attention to the Fed, they are paying attention to us. In a nod toward equity markets, the minutes clearly state:
Several participants indicated that recent trends in euro-area equity indexes and sovereign debt yields had not been encouraging, and some noted that the uncertainty prevailing in global financial markets was showing through in a cautious posture of investors.
This is as bold a statement as I have seen that Fed policymakers are pursuing policy based (at least partly) on investor behavior. From an economic perspective, this type of short-term focus in monetary policy is potentially dangerous, but from an investor perspective it is probably the clearest hint as to what's to come.
Most analysts are reading the minutes as an indication that QE3 will arrive in September, but I am less convinced. The domestic economic data since the last meeting has been marginally positive, even as global indicators are negative. With the Germans now supporting Draghi, Europe should get a reasonable boost from Jackson Hole and the September 6 ECB meeting. This could help buoy global markets and give the Fed time to more completely evaluate their lending stimulation options. Since the makeup of the FOMC favors doves and will continue to through 2013, I don't see Chairman Bernanke rushing to more easing, but his speech at Jackson Hole will certainly give us a much better indication of what to expect when the FOMC meet on September 12-13.