Fed Signals Fear of Double Dip
The recovery has stalled. That's the message from the Federal Reserve's monthly Open Market Committee (FOMC) meeting. Its economists must be very worried about a double dip. Rather than maintain a stay-the-course strategy under the assumption of a slow recovery, they have decided to further loosen monetary policy. The Fed will reinvest the principal it obtains from its maturing mortgage-related securities and Treasuries in longer-term Treasury securities. This shows that the FOMC is very concerned about the U.S. economy, as it attempts to now keep down longer-term interest rates.
Let's start with the August statement's language about the recovery, or lack thereof:
Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months.
That might not sound like much, but it's a pretty big change in Fed-speak compared to what the Fed's statement said in June:
Information received since the Federal Open Market Committee met in April suggests that the economic recovery is proceeding and that the labor market is improving gradually.
So in about seven weeks, the committee has gone from thinking the labor market is improving gradually to believing that its recovery has slowed. That's a little bit surprising, considering that the private sector actually added more jobs in July than it did in May.
Here's the only other key change to the August statement -- the bombshell that the Fed will reinvest some maturing assets:
To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve's holdings of Treasury securities as they mature.
Before, the Fed had intended to just let these principal payments come in without reinvesting. But now it's using that cash to buy longer-term Treasuries -- which will significantly target long-term maturities. Even though the short-term Federal Funds Rate is held close to zero, this shows that the Fed wants to keep down longer-term rates as well. All voting members agreed with the action except for maverick Kansas City Fed President Thomas Hoenig, who continues to worry about inflation.
Speaking of the price level, while the Fed acknowledges that inflation has trended lower in recent quarters, it makes clear that it still isn't worried about deflation. It calls longer-term inflation expectations "stable." That's despite some economists worrying that a disastrous Japan-like deflationary cycle could capture the U.S. economy if prices continue to decline.
This is certainly one of the most significant FOMC statements we've seen in a while. The Fed made clear that it still doesn't believe deflation is a problem, which would have been significant enough news in most months. But the committee also acknowledged that the labor market recovery appears to have stalled and took some modest action to try to get the economy moving again. Will the market treat this move as great news that the Fed really cares, or realize that the economy must be in really awful shape if the central bankers felt the situation was urgent enough to further loosen monetary policy?