Monetary Policy: What’s in a Few Words?
The Federal Open Market Committee (FOMC) left the target level of the federal funds rate unchanged at 5.25 percent this afternoon. It was the eighth consecutive meeting at which the rate was held steady. The inflation-adjusted fed funds rate rests near 3 percent, or about 400 basis points above its low of June 2004.
Any changes in the policy rate would have come as a great surprise to market participants. Indeed, implied yields and estimated probabilities based on fed funds futures indicate that a rate change is not likely before the end of the year. An adjustment to the post-meeting statement language, on the other hand, was widely anticipated.
Language changes were seen as necessary to account for the evolution of the outlook for both inflation and economic growth since the last meeting. In its rationale for the May meeting decision, where rates were held steady, the FOMC said that economic growth had slowed and core inflation remained “somewhat elevated.” Two favorable readings on CPI core inflation and some good news on economic activity altered the FOMC’s basis for its rationale. The June statement reads: “ Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated.”
Concerning economic growth, the statement reads “Economic growth appears to have been moderate during the first half of this year, despite the ongoing adjustment in the housing sector.” This compares with the May meeting statement, “Economic growth slowed in the first part of the year and the adjustment to the housing sector is ongoing.” In the FOMC’s assessment of risk, the statement repeated last meeting’s language that “the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected.”
Initial market reaction saw both equity prices and bond yields rise. Then after some erratic movements (the S&P index dropped briefly into negative territory), stocks finished the trading session lower than just prior to the statement’s release and virtually unchanged on the day. The 10-year Treasury yield finished the day higher by about 5 basis points and near the level to which it jumped immediately after the announcement.