The focus of the Federal Reserve’s upcoming policy meeting once again turns not on what the Fed does with interest rates but rather what officials say about the economic and inflation outlook.
The language policymakers use, as well as any sign of disagreement among Fed members, could settle lingering questions in financial markets about whether the Fed lays the groundwork for rate increases later this year or instead confirms the growing view that rate hikes are unlikely before 2009.
At Tuesday’s meeting, officials are widely expected to hold the target federal-funds rate at which banks lend money to each other unchanged at 2% for a second-straight time, putting greater focus on the accompanying statement.
In its last policy statement June 25, officials signaled that higher inflation matched, or even exceeded, weak growth as their top concern. “Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased,” the Fed said.
While futures markets still priced in roughly even odds of an October rate increase even after the jobless-rate increase, Fed watchers increasingly see officials on hold into 2009. That view gained traction following a decision Wednesday by the Fed to extend loans to investment banks through January. That program was originally scheduled to expire in September.
Fed officials “would not have done what they did if they hadn’t recognized that there’s still a lot of fragility in financial markets,” said Lyle Gramley, a former Fed governor now with the Stanford Group.
Next week’s meeting will also reveal whether a supposed split between the Washington-based Board of Governors and several regional banks is real or rhetorical.
The FOMC voted 9-1 to hold rates steady in June. But Fed watchers thought the lone dissent — by Dallas Fed President Richard Fisher – masked greater division. The Board of Governors — there are five now, seven at full strength — have voted in lockstep for many years. But since most regional presidents only vote once every three years, the preference of many officials isn’t known.
But in June, directors at the Kansas City Fed joined Dallas in requesting a quarter-point increase in the discount rate the Fed charges commercial and investment banks for direct loans, suggesting Kansas City Fed President Thomas Hoenig may have dissented if he had a vote this year. Some Fed watchers assume Richmond Fed President Jeffrey Lacker would also dissent if he could, since he ended his last spell as a voter in 2006 with four-straight dissents in favor of higher rates.
Among this year’s FOMC voters, analysts are eyeing Philadelphia Fed President Charles Plosser – a past dissenter — and Minneapolis Fed President Gary Stern, whose more than two decades as bank president make him the longest-serving Fed policymaker.
The Fed may need to increase “sooner rather than later,” Plosser said recently. Stern also talked tough on inflation since the June meeting.
If there’s only one dissent again, “it would suggest that the [anti-inflation] hawks were really trying to talk down inflation expectations but don’t have enough of a disagreement with policy” to actually cast a dissenting vote, said Lehman Brothers economist Zach Pandl.
“The hawks have lost a little bit of their ammunition with the decline in oil prices,” Gramley said. Gramley expects Fisher to again be the lone dissenter on Tuesday. –Brian Blackstone
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