FOMC Preview

Whatever thunder the FOMC meeting usually has is being stolen this week by the first of Bernanke's quarterly press conferences tomorrow. In fairness, the FOMC's statement is unlikely to change substantively from the mid-March statement. The press conference has potential to be more disruptive, but even here it is best to keep in mind the distinction between transparency and visibility.

Turning first to the statement itself, it will be released tomorrow around 12:30 EST. The statement is fairly formulaic in its present incarnation. The first paragraph is the economic assessment. While there is no doubt the recovery is continuing the statement will likely acknowledge some moderation in the pace--to recognize the likelihood of a sub-2% Q1 GDP figure. The continued rise in commodity prices. The statement may also recognize that some long-term inflation expectations have risen as a result. Note that the 5-year/5-year forward has risen almost 80 bp since the last FOMC meeting.

In the second paragraph, the FOMC discusses its mandates and it will likely continue to claim that the increase in inflation/expectations will be transitory. That said, officials appear to have ratcheted up the vigilant rhetoric and this may also be reflected in this paragraph.

The third paragraph is about policy. The Fed will continue to complete its $600 bln purchases of Treasuries. The fourth and fifth paragraphs deal with the Fed funds target and Fed's pledge to continue to monitor developments.

The last paragraph is the vote. Of note, despite the seemingly divergent views, there have been no dissents at this year's meetings. No one has voted to stop QEII. No one has rejected the Fed's wording that conditions will likely warrant exceptionally low yields for an extended period of time. It appears that just before Bernanke's press conference, the new quarterly staff growth/inflation forecasts will be released. Usually they are released with the FOMC meeting minutes. Growth and unemployment are likely to be tweaked lower and inflation higher to recognize the recent string of data.

We are under the impression that this is not really Bernanke's first press conference, but his first public press conference. There has been some indication that there may have been off-the-record press conferences with reporters previously. Still the public nature of this one is new and has potential to inject some short-term volatility.

There seems to be three broad areas that reporter will focus on: policy, inflation and the dollar. In terms of policy, it may become clearer that QEII is the $600 bln of Treasury purchases. The reinvesting of principal payments into Treasuries is not really part of QEII but part of the Fed's efforts to maintain the size of its balance sheet and not to accept the passive contraction at a pace dictated by early prepayments or maturing issues. Our understanding is that over the next few quarters, there is not a lot of Treasuries the Fed holds that are maturing.

Bernanke may also try to explain why the Fed is not worries about who will buy Treasuries when QEII is completed and the answer is to be found in the Fed's understanding of its operation and why it typically does not call it quantitative easing. It is essentially buying Treasuries with another asset (reserves) and it understanding of the impact is not based on the availability of credit but on the reduction of supply of long-term risk-free asset and the knock on effects, including rising equities and a weaker dollar.

Some reporters may also ask Bernanke about the dollar. Bernanke is likely to acknowledge that dollar policy is set by the Treasury, but the Fed takes it into account in terms of its impact on inflation and growth and that it is part of the transmission mechanism of monetary policy.

Lastly, we would emphasize that a press conference may increase transparency without increasing visibility of the next Fed steps or the timing. The increased transparency lies in the process. Investors are unlikely to learn from Bernanke when the Fed will tighten as it is doubtful that he himself knows.