FOMC Meeting Update – December, 12 2012


Written by: Jon McGraw

The Federal Open Market Committee has been meeting for the past few days and came to a new conclusion, at least from the angle of how current easing decisions are being made and communicated. The group is changing its method of fed funds rate guidance from the current ‘calendar-based’ approach (stated goal as mid-2015) to an ‘outcome-based’ method—a change which has been hinted at and endorsed by a variety of economists for several months. So, it isn’t really a huge surprise.

What does this mean? In this case, the Fed has tightened up the criteria from a target date several years in the future and, instead, announced various landmarks that specify what needs to happen in order for their foot to be taken off the gas pedal. These include: the unemployment rate falling to 6.5%, 1-2 year look-ahead inflation projections being no higher than 2.5%, and long-term inflation expectations remaining ‘well-anchored’ (which leaves a bit of wiggle-room in this definition—with our noting that ‘long-term’ inflation levels have ranged 2.5-3.5% over the decades). This may not change things all that much, as the unemployment rate target mentioned is still closely aligned with forecasted mid-2015 levels, but this does provide more clarity on the underlying numbers most important to the Fed.

The Fed’s ‘Operation Twist’ (which consists of selling short-dated and buying longer-dated government debt to flatten or ‘twist’ the natural yield curve) expires at the end of December. However, it doesn’t appear the Fed is ready to cease the bond-buying program just yet, and stated a continuation of these purchases at a rate of $85 billion/month (split roughly equally between Treasuries and MBS), with the possibility of this number changing with time and conditions.

No other critical changes in the perceived economic environment were communicated, other than a reference to recent weather-related disruptions and mention of eased inflation concerns.

What’s in store for 2013? Much of this depends on the direction and speed of the economic recovery. For this reason, it wasn’t out of the realm of possibility to see general targets set as a method to plan an exit strategy from this current stimulative environment as well as continued QE. Remember, the Fed has operated under a dual mandate since 1977—price stability and maximum employment—unlike many of the world’s central banks that are only focused on the former. This ties their hands a bit more toward the political angle of the unemployment situation. Naturally, what can help employment sometimes runs counter to what might be good for monetary policy…this is a difficult balancing act and usually results in the choice of one over another. For now, the need for more jobs wins.