Fed Saves Bullets for Another Day

Following a run of poor economic data and cautious commentary by the Fed Chairman Ben Bernanke at his bi-annual testimony in front of Congress, markets were raising expectations for a fresh round of quantitative easing by the Fed. Markets would stabilize on expectations of further Fed action. This bought the Fed some much needed time. Instead of firing some of it's 'bullets', the Fed was able to maintain the verbal intervention policy in the August 1 directive. Perhaps the most surprising aspect was that the Fed left it's '2014' Language in rather than extend the outlook for accomodative policy to 2015 as many expected.

Given it's past history and the Mr. Bernanke's well deserved reputation as a proactive Fed Chairman, the Fed has been able to keep market vigilantes at bay. There were small tweaks made from the June 20 statement but given it's history it should be enough to keep expectations of QE at the forefront and put some pressure on it's European counterpart to take the lead.

Notable Changes in Fed Statement

-- Aug 1- Information received since the Federal Open Market Committee met in June suggests that economic activity decelerated somewhat over the first half of this year... June 20- Information received since the Federal Open Market Committee met in April suggests that the economy has been expanding moderately this year.

-- Aug 1- The Committee will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability... Jun 20- The Committee is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.

There were some changes to the fourth  paragraph but recall the extension of 'Operation Twist' was announced in the June 20 directive. This caused some minor changes in the statement but for the most part remained in the spirit of the prior statement.

What Stayed the Same

-- Growth in employment has been slow in recent months, and the unemployment rate remains elevated. Business fixed investment has continued to advance. Household spending has been rising at a somewhat slower pace than earlier in the year. Despite some further signs of improvement, the housing sector remains depressed. Inflation has declined since earlier this year, mainly reflecting lower prices of crude oil and gasoline, and longer-term inflation expectations have remained stable.

-- Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects economic growth to remain moderate over coming quarters and then to pick up very gradually. Consequently, the Committee anticipates that the unemployment rate will decline only slowly toward levels that it judges to be consistent with its dual mandate. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee anticipates that inflation over the medium term will run at or below the rate that it judges most consistent with its dual mandate.

-- To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.

Taking A Look at Changes to Economic Commentary Ahead of QE 1 and QE 2 and 'Operation Twist'

If the Fed wants to raise anticipation of a fresh round of action, one expects them to provide a more cautious outlook. One of the key changes noted above was the Fed lowering it's description of the economy (see first bullet point in the 'Notable Changes' section)

-- In his July 17 testimony, Fed Chairman Bernanke in his opening remarks stated: 'The U.S. economy has continued to recover, but economic activity appears to have decelerated somewhat during the first half of this year'. This was a change from the June 20 directive in which the Fed described the economy as 'expanding moderately this year'.

-- In the Oct 8, 2008 statement (ahead of QE 1) the FOMC said: 'Incoming economic data suggest that the pace of economic activity has slowed markedly in recent months'. And recall, the Fed expanded QE 1 in March 2009 which followed the January 28, 2009 statement that the economy had 'weakened further'.

-- In the September 21, 2010 (ahead of QE 2) the FOMC said: 'Information received since the Federal Open Market Committee met in August indicates that the pace of recovery in output and employment has slowed in recent months'.

-- And finally in August 2011 (ahead of Op Twist) the Fed said: 'Information received since the Federal Open Market Committee met in June indicates that economic growth so far this year has been considerably slower than the Committee had expected'.

The theme here is that it noted a slow down in the economy on each occasion. And the fact that it changed the economic description to 'decelerating' from 'expanding modertately' sets the table for the Fed to announce further actions in September. Whether or not they do remains to be seen but they have certainly used verbal intervention as their primary tool once again.