Vital Signs: A More Upbeat Fed?

The main event for the markets this week will be the Federal Reserve's two-day policy meeting, beginning on Tuesday and concluding with the Fed’s always eagerly–awaited policy statement at 2:15 p.m. on Wednesday. Analysts expect the Fed to sound a bit more upbeat about the economic outlook compared to its August statement, when it said economic activity was "leveling out." In fact, recently renominated Fed Chairman Ben Bernanke noted on Sept. 15 that the recession is "very likely over" at this point.

All this pretty much settles the question of whether the Fed will increase the size of its asset-purchase programs. Indeed, the markets are now looking for clues as to when policymakers will begin to slow their rate of such purchases in advance of ending the programs outright. With its purchase of $300 billion in Treasury securities almost complete, the Fed has already said it will slow its rate of buying Treasuries in order to avoid disruption to the markets. Planned Fed purchases of $1.45 trillion in mortgage-backed securities and federal agency debt are only about half-way completed. The markets will be looking for any change in the planned volume or timing of these purchases as a possible early sign of a shift in policy thinking.

However, an improving outlook doesn’t mean higher interest rates are any closer now than they were a month ago. Indeed, the bottom line from the Fed’s statement will most likely be that, amid concerns about the strength and sustainability of the recovery, the Fed will remain committed to keeping its target interest rate at "exceptionally low levels" and "for an extended period."

Consistent with those concerns, the Fed’s Sept. 9 Beige Book report, a summary of economic conditions in each of the Fed’s 12 districts, characterized the outlook as "cautiously optimistic," while noting decidedly mixed reviews on business activity. The report, prepared in advance of each policy meeting, said consumer spending remained sluggish, and while labor markets showed signs of improvement in some districts, hiring conditions were generally weak. Manufacturing looked stronger, and residential real estate showed improvement, but commercial real estate was weak. Also, demand for loans continued to sag, and credit conditions remained tight.

In general—a couple of hawkish-sounding policymakers notwithstanding—the potential inflationary consequences of current policy are very low on the Fed’s worry list right now. In fact, many private-sector economists believe the risk of deflation remains higher than the chances of inflation over the next year or so. Over the past year, the Fed’s preferred measure of core inflation, which excludes the ups and downs in energy prices, has slid from 2.7% to 1.4%, and history shows that in all recessions going back to the 1970s, core inflation has continued to fall for about two years after recessions have ended.

In an economy with as much slack, or unused labor and production capacity, as this one, the risk that core inflation could fall to zero, or below, is significant. That’s a risk the Fed will not be willing to take by prematurely hiking interest rates until the recovery is well established.

Here’s the weekly calendar, from Action Economics.

  Top Economic Reports Report Date Time For Median Estimate Last Period Leading Indicators Monday, Sept. 21 10:00 a.m. August 0.4% 0.6% Existing Home Sales (Millions) Thursday, Sept. 24 10:00 a.m. August 5.255 5.240 Durable Goods Orders Friday, Sept. 25 8:30 a.m. August 1.1% 5.1% Consumer Sentiment Index (Preliminary) Friday, Sept. 25 9:55 a.m. September 67.0 70.2 New Home Sales (Millions) Friday, Sept. 25 10:00 a.m. August 0.445 0.433

  Other Reports and Events Report/Event Date Time For ICSC-UBS Store Sales Tuesday, Sept. 22 7:45 a.m. Sept. 13-19 Johnson Redbook Weekly Store Sales Tuesday, Sept. 22 8:55 a.m. Sept. 13-19 Federal Reserve Policy Meeting (First Day) Tuesday, Sept. 22 9:00 a.m. FHFA Home Price Index Tuesday, Sept. 22 10:00 a.m. July Richmond Fed Survey Tuesday, Sept. 22 10:00 a.m. September Mortgage Applications Wednesday, Sept. 23 7:00 a.m. Sept. 13-19 Federal Reserve Policy Meeting (Second Day) Wednesday, Sept. 23 2:15 p.m. Statement Initial Unemployment Claims Thursday, Sept. 24 8:30 a.m. Sept. 13-19 Kansas City Fed Survey Thursday, Sept. 24 11:00 a.m. September SPEECH: Fed Governor Warsh Friday, Sept. 25 1:15 p.m.

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