FOMC Statement: 1st Reaction

by: Tim Duy

The June FOMC statement has been released and it sent a clear signal that the door to scaling back asset purchases was now wide open. Two key sentences stand out. First, on inflation:

Partly reflecting transitory influences, inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable.

This sounds like the FOMC continues to downplay the recent slide in inflation and instead focus on the longer-term forecast and stable inflation expectations. Thus, inflation is as of yet not an impediment to scaling back asset purchases. Second, despite the weight of fiscal contraction:

The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall.

One justification for QE3 and the conversion of Operation Twist to an outright purchase program was to protect against downside risks, primarily fiscal policy. If those risks are diminishing, so too is the case for the current rate of asset purchases.

The decision was not unanimous. Earlier this month I wrote:

Indeed, I suspect that at least one policymaker, current voting member St. Louis Federal Reserve President James Bullard, would push for expanding asset purchases given the inflation and inflation expectations data. It would be interesting if he dissented a 'hold steady' statement at the next meeting on that basis.

Bullard did indeed dissent, on the other side of Kansas City Federal Reserve President Esther George's dissent:

Voting against the action was James Bullard, who believed that the Committee should signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings, and Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations.

Interesting that only Bullard seems to be concerned about low inflation. Are others ignoring inflation because it is inconvenient in light of the hope to scale back asset purchases sooner than later? Regarding the forecasts, near-term growth forecasts edged down, while the downward-revised inflation forecast was a little more aggressive. But the improvement in the unemployment forecast is most important assuming the Fed wants to end asset purchases prior to hitting the 6.5% threshold, now seen as early as the end of net year.