Wednesday, June 24, 2009

The Fed Speaks: "The pace of economic contraction is slowing"

The Fed announcement this afternoon was largely uneventful and the committe reiterated its use of existing policy tools. The only real surprise was that the FOMC didn't introduce any hints of an exit strategy given the risk of the massive growth of the monetary base. An exit strategy with the goal of soaking up excess liquidity will be crucial in the coming 18 months or so as inflation dangers become a reality. While the Fed didn't introduce any plans to reduce it's role in the private debt markets, it has laid the groundwork for an eventual reversal of its position and slimming down of its bloated balance sheet.

Let's take a look at the first two sentences of the FOMC statements from the last three meetings. These sentences are very similar with minor differences in language, reflecting the thinking of the FOMC. You can get the complete press releases here.

March 18, 2009:
Information received since the Federal Open Market Committee met in January indicates that the economy continues to contract. Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending.
April 29, 2009:
Information received since the Federal Open Market Committee met in March indicates that the economy has continued to contract, though the pace of contraction appears to be somewhat slower. Household spending has shown signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit.
June 24, 2009:
Information received since the Federal Open Market Committee met in April suggests that the pace of economic contraction is slowing. Conditions in financial markets have generally improved in recent months.

Comparing the statements shows that the Fed firmly believes that the economy is on the mend and that we are near the bottom. Take a look at the language the Fed is using: Press releases from March and April are void of any positive words or hopeful indicators. The first two sentences of these statements contain the words, "contract," "losses," and "declining." Only in the June statment does the Fed use a positive word, "improved," in it's opening sentences. While the statements reflect the current state of the economy as the Fed sees it, the changes in tone are notable as the Fed lays the groundwork for eventually unwinding its recent purchases and working to stave off impending inflationary pressure. Expect to see more obvious references to an exit strategy in August and September as the FOMC seeks to brace markets.