Preview FOMC: Two Key Issues

The FOMC meets Tues and Wed this week. With no expectation of a change in the Fed funds target, the key focus is on the assessment and guidance the Federal Reserve provides.

Since the FOMC last met in August, the inflation data has not changed very much. However, its assessment that it began the second paragraph of its August statement with that "the prices of energy and other commodities have risen of late" seems somewhat less true. Commodity prices are more mixed, with oil prices generally stable since early August, for example, and prices for some food stuffs, such as wheat and soy and live cattle are lower. The year-over-year core rate of CPI stood at 1.4% in Aug, the lowest rate since early 2004.

Rather than its inflation assessment, the larger change may lie with its economic assessment. Last month the Fed said that "economic activity was leveling out". This assessment needs to be revised as evidence suggests stronger economic activity is likely here in Q3 and Q4. There is potential for some nuance here.

Even though there has been only one double-dip recession since the Great Depression, there is concern among many, including some at the Fed, that the economic drivers may prove temporary, such as inventory adjustments and government support.

The Fed's assessment of the economic drivers is important because it will influence the FOMC's guidance. In particular, since March, the FOMC has stated that the exceptionally low level of Fed funds would likely be appropriate for an extended period of time. A change in this guidance would be exceptionally important.

What is more important for the FOMC at the moment? Acknowledging that likelihood of stronger growth or re-affirming a prolonged period of low rates? The double-dip--during the Great Depression and the early 1980s was at least partly the result of premature tightening of monetary policy. Given the cautious stance of Bernanke, one of the leading students of the Depression, the FOMC is likely to keep its guidance unchanged, even if that means tempering the economic assessment.

Lastly, we note that the Federal Reserve continues tweak its various lending and support facilities. It is possible that the FOMC announces additional adjustments. One in particular that some observers anticipate is to slow the rate of purchases of mortgage-backed securities and agency bonds, as they previous indicated they would do with their Treasury purchases. Such a development has already been largely telegraphed and would not have much "news content". Just the same though, the FOMC statement typically does not carry such announcements, separating the conduct of monetary policy from its efforts on the liquidity front and credit easing policies.