FOMC Minutes: More MBS Purchases Coming

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Gold jumps, dollar drops on FOMC minutes. The market now believes gold is a better inflation hedge than the dollar.

More MBS purchases coming:

The Committee emphasized that it would continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. A few members noted that resource slack was expected to diminish only slowly and observed that it might become desirable at some point in the future to provide more policy stimulus by expanding the planned scale of the Committee’s large-scale asset purchases and continuing them beyond the first quarter, especially if the outlook for economic growth were to weaken or if mortgagemarket functioning were to deteriorate.

Fed thoughts on Reverse Repos:

The staff presented another update on the continuing development of several tools that could be used to support a smooth withdrawal of policy accommodation at the appropriate time; these tools include executing reverse repurchase agreements (RRPs) on a large scale and implementing a term deposit facility (TDF). To further test its RRP capabilities, in early December, the Desk executed a few small RRPs with primary dealers, using both Treasury and agency debt as collateral. These transactions confirmed the operational capability to execute triparty RRPs on a larger scale if so directed by the Committee. The Desk was continuing to develop the capacity to conduct RRPs using agency MBS collateral and anticipated that this work would be completed by the spring. In addition, the Desk reported that it was exploring the operational issues associated with expanding potential counterparties for RRPs beyond the primary dealers. Staff also reported significant progress in developing and implementing a TDF. The staff noted that it planned to ask the Board to approve a Federal Register notice requesting public comments on a TDF and summarized the contents of the draft notice.

Financial situation review:

Market participants largely anticipated the decisions by the Federal Open Market Committee (FOMC) at the November meeting to keep the target range for the federal funds rate unchanged and to retain the “extended period” language in the accompanying statement. However, market participants took note of the Committee’s explicit enumeration of the factors that were expected to continue to warrant this policy stance, and Eurodollar futures rates fell a bit on the release. In contrast, the announcement that the Federal Reserve would purchase only about $175 billion of agency debt securities had not been generally anticipated. Spreads on those securities widened a few basis points follow-ing the release, but declined, on net, over the intermeeting period. Incoming economic data, while somewhat better than expected, seemed to have little net effect on interest rate expectations. Indeed, the expected path of the federal funds rate shifted down somewhat over the intermeeting period. Consistent with the decrease in short-term interest rates, yields on 2-year nominal off the-run Treasury securities declined slightly, on net, over the intermeeting period. In contrast, yields on nominal 10-year Treasury securities edged higher on balance. Inflation compensation based on 5-year Treasury inflation-protected securities (TIPS) increased, apparently owing in part to an announcement by the Treasury of a smaller-than-expected amount of issuance of TIPS next year. Five-year inflation compensation five years ahead also rose, and was near the upper end of its range in recent years.

View on inflation:

The staff forecast for inflation was nearly unchanged. The staff interpreted the increases in prices of energy and nonmarket services that recently boosted consumer price inflation as largely transitory. Although the projected degree of slack in resource utilization over the next two years was a little lower than shown in the previous staff forecast, it was still quite substantial. Thus, the staff continued to project that core inflation would slow somewhat from its current pace over the next two years. Moreover, the staff expected that headline consumer price inflation would decline to about the same rate as core inflation in 2010 and 2011...Some noted the risk that, over the next couple of years, inflation could edge further below the rates they judged most consistent with the Federal Reserve’s dual mandate for maximum employment and price stability; others saw inflation risks as tilted toward the upside in the medium term...Participants noted that any tendency for dollar depreciation to put significant upward pressure on inflation would bear close watching.

 

Most participants anticipated that substantial slack in labor and product markets, along with well-anchored inflation expectations, would keep inflation subdued in the near term, although they had differing views as to the relative importance of those two factors. The decelerations in wages and unit labor costs this year, and the accompanying deceleration in marginal costs, were cited as factors putting downward pressure on inflation. Moreover, anecdotal evidence suggested that most firms had little ability to raise their prices in the current economic environment. Some participants  noted, however, that rising prices of oil and other commodities, along with increases in import prices, could boost inflation pressures going forward. Overall, many participants viewed the risks to their inflation outlooks as being roughly balanced. Some saw inflation risks as tilted to the downside, reflecting the quite elevated level of economic slack and the possibility that inflation expectations could begin to decline in response to the low level of actual inflation. But others felt that inflation risks were tilted to the upside, particularly in the medium term, because of the possibility that inflation expectations could rise as a result of the public’s concerns about extraordinary monetary policy stimulus and large federal budget deficits. Moreover, a few participants noted that banks might seek, as the economy improves, to reduce their excess reserves quickly and substantially by purchasing securities or by easing credit standards and expanding their lending. A rapid shift, if not offset by Federal Reserve actions, could give excessive impetus to spending and potentially result in expected and actual inflation higher than would be consistent with price stability. To keep inflation expectations anchored, all participants agreed that monetary policy would need to be responsive to any significant improvement or worsening in the economic outlook and that the Federal Reserve would need to continue to clearly communicate its ability and intent to begin withdrawing monetary policy accommodation at the appropriate time and pace.

Full FOMC report: