The FOMC meets this week. While slower perhaps than desirable, the Fed officials should be generally pleased with the trajectory of developments since they met last in late January. On the real economy side, Q4 09 turned out to be quite strong at 5.9% and the Q1 10 appears to be tracking something closer to 3%. Of course, Q4 was flattered by a large shift in the inventory component which no one expects to be sustained. Consumption and hourly earnings are rising.
The Fed has cited three metrics they are watching to help determine the appropriateness of current rates: resource utilization, inflation expectations and inflation. In terms of resource utilization, the unemployment rate appears to have steadied for the moment, but it will likely be too early for officials to have much confidence. On industrial side, plenty of capacity still exists and manufacturing employment rose in both Jan and Feb. The poor weather may have seen the trend improvement in utilization rates stall (to be reported today March 15), but should be expected to resume as the winter thaws.
There are various measures of inflation expectations Fed policy makers will access, but for a general view we would not that the yield curve (2-10 yr) has flattened over the past month and the 5-yr/5-yr forward fell from 2.75% around the time of the last FOMC meeting to 2.36% before recovering to trade around 2.55%, the middle of the lower range seen since.
Inflation itself has been largely steady. The core rate of CPI was negative in January for the first time in more than a quarter of a century. The key drag here appears to be coming from the owner equivalent rents. Rather than a reflection of the general price level, the pressure on the core rate is a function of the housing market.
Since the Fed met last, the data from the housing market suggests it has weakened again, even if some allowance is made for the weather. The Fed could mention this in its statement.
Also the last FOMC statement expressed concern about the decline in bank credit for the first time. It appears that bank credit has continued to contract and the statement will likely reflect this. While consumer credit did increase in January for the first time in a year, the increase was a reflection of the Federal government's student loan program.
There is some speculation that Fed officials are looking for some way to change the language to help modify expectations about its extraordinary policy stance. The key phrase that many are focusing on is "extended period". Previously--Dec 08-Jan 09 the Fed used the phrase "for some time."
While it is possible, and we suspect it is coming, this week's meeting may be too soon. At this juncture, nothing is lost by waiting another month. More Fed-speak--verbally preparing the market may be deemed necessary. There are a number of Fed officials who are scheduled to speak in the second half of the week.
