The Latest FOMC Minutes

By Danielle Hale, Research Economist

Markets react to the Federal Open Market Committee minutes and other economic data…

Before the release of the minutes from the March meeting of the Federal Open Market Committee (FOMC) the market expected the FOMC to continue rate cuts at its April meeting. The implied probability-implied by futures contracts-was a 60 percent likelihood of a 2.0 percent Federal Funds rate and approximately a 35 percent likelihood of a 1.75 percent Fed Funds rate meaning the market expected an additional cut of between 50 and 75 basis points at the April 29-30 meeting. After the release of the minutes yesterday, implied expectations for a 2.0 percent rate dropped slightly while those for lower rates were slightly raised.

Market participants who examined the minutes looking for signs that Richard W. Fisher and Charles I. Plosser, who preferred less aggressive action at the March meeting, were not alone in their sentiments though they were the only two to vote against the last rate cut, seem not to have found signs of that. Mr. Plosser's attention seemed to be well-focused on inflation. He pointed out, "that the Committee could not afford to wait until there was clear evidence that inflation expectations were no longer anchored, as by then it would be too late to prevent a further increase in inflation pressures."

Others however have concerns about growth, believing that "a prolonged and severe economic downturn could not be ruled out given the further restriction of credit availability and ongoing weakness in the housing market." For now, the market seems to think that the data and influence will rest with those who are cautious about growth and likely favor some further easing. Whatever power markets may ascribe to the FOMC, the minutes show that its members are aware of limitations: "Members recognized that monetary policy alone could not address fully the underlying problems in the housing market and in financial markets, but they noted that, through a range of channels, lower short term real interest rates should help buoy economic activity and ameliorate strains in these markets."

Why does the release of the minutes matter?

The FOMC is now much more open than it used to be and releases a statement after each meeting. This statement gives the target policy change, a brief summary of the rationale for the adjustment, and a list of the members who voted for and against the measure. However, the minutes that are released 3 weeks later delve more deeply into the economic reasoning behind the action and any discussion that occurred. The minutes may yield insight into whether any variety of opinion exists on the committee that is more nuanced than can be captured in a simple vote record.

The members may not think exactly alike, so what?

Barron's calls the FOMC meetings, "the single most influential event for the markets." Why? Policy makers on the FOMC meet to set the target federal funds rate, the rate banks charge each other for overnight lending. The Federal Reserve then uses other tools to aim for this rate which works its way through the system to affect rates on everything from Treasury bonds to mortgage loans. The target rate's impact eventually leads to an effect on employment, output, and prices-the broad measures of the economy.

You will hear from some, those who celebrate rate cuts and deplore rate hikes by the FOMC, that higher interest rates are bad for the economy and lower interest rates are good for the economy. As I wrote in an earlier commentary, this is only part of the story. The full story is that higher real interest rates make borrowing expensive and tend to choke out consumption and investment, two components of economic growth. Lower real interest rates make borrowing cheap, and are therefore associated with greater economic growth*.

Because these rates are so important, economists and others closely watch and analyze FOMC members statements and economic data to predict what the FOMC may do-by "Fed watching" market participants attempt to avoid surprises and make enlightened decisions about the likely course of Fed action and its impact on economic variables.

Fed watchers pay attention to both economic data and every word that comes from the FOMC, the whole committee or its individual members. As with any human decision, the FOMC effort is partly grounded in sound economic reasoning, and partly grounded in human gut instinct that is subjective and at times swayed by political or other concerns not directly related to the economy. Furthermore, the decision is made by committee, and, to a degree, subject to the interactions of personalities and their opinions. Fed watchers try to incorporate these human factors along with the data into their predictions of likely outcomes.

What will happen?

Of course it is still early. Fed watchers are now folding the information from the minutes into their predictions, but three weeks remain before the next FOMC meeting, and a lot will happen between now and then. The stock market has buoyed since the last FOMC meeting. Consumer sentiment is released this Friday; retail sales, inflation, and production data will be out next week. Bernanke is slated to speak today and Thursday and other FOMC members are out and about as well. According to futures contracts, some cut is likely, though NAR Chief Economist Lawrence Yun does not have it in his latest forecast. No one can know exactly what Bernanke and the FOMC will decide to do in late April, but with all the scrutiny they face, we can be sure the FOMC decision will be fully considered.

* When inflation is low, as it has been for the last decade, people do not lose much if they ignore the difference, but if inflation picks up, not noting the difference between the two is problematic because seemingly high nominal rates can actually be very low or even negative real rates. For an example, see September 1972–August 1974. At the time, nominal rates for first-time mortgages were between 7.42 and 9.59 percent, but after accounting for CPI inflation, real rates were zero or negative for that entire period. We are not, and have not been in negative real rate territory since the late 1970s. Even at the height of the housing boom in 2004 and 2005, real rates dropped below 1 percent only once, to 0.9percent in October 2004. Real rates were in the 1–3 percent range in 2007, and have risen slightly in 2008 based on currently estimated inflation (CPI). These measures of inflation are subject to revision.

 

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