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Weekly Economic Commentary 01-23-2012

Weekly Economic Commentary 01-23-2012

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Monetary policy will take center stage this week in the United States as the
FOMC (the Fed’s policymaking arm) holds the first of its eight meetings this
year on January 24 – 25.
Monetary policy will take center stage this week in the United States as the
FOMC (the Fed’s policymaking arm) holds the first of its eight meetings this
year on January 24 – 25.

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Published by: monarchadvisorygroup on Jan 24, 2012
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 Member FINRA/SIPCPage 1 o 5
Weekly Economic Commentary
The Federal Open Market Committee (FOMC) meeting, along with FederalReserve (Fed) Chairman Bernanke's press conerence and a new economicand interest rate orecast rom the Fed, is likely to compete or the market'sattention with the return o Congress, the debate over the payroll tax cutextension, and another ull slate o ourth quarter earnings reports this week.Economic data will also vie or attention with data due out on manuacturing,housing, leading indicators, and ourth quarter gross domestic product (GDP).Monetary policy will take center stage this week in the United States as theFOMC (the Fed’s policymaking arm) holds the rst o its eight meetings thisyear on January 24 25. With the Fed’s target interest rate near zero andOperation Twist the Fed selling some o its holdings o shorter termTreasuries to und purchases o longer dated Treasuries in order to keepbusinesses' and consumers’ borrowing costs lower or longer — wellunderway, the market’s attention is likely to be on:
The Fed’s latest economic orecast, which will likely include, or the rsttime, the Fed’s own orecast o the ed unds rate,
Any changes to the FOMC statement,
Bernanke’s press conerence, and
The composition o the FOMC.
Changing the Forecast
Since the release o the most recent Fed minutes (January 3, 2012), mostmarket participants expect the Fed to begin publishing a orecast or thepath o the Fed unds rate, the rate set by the Fed to control overnightborrowing between banks, at the conclusion o this week’s FOMC meeting.The Fed publishes its economic orecast our times a year (January, April,June and October/November). The orecasts currently include:
Real GDP,
Consumer Price Infation (CPI),
“Core infation” (the Fed’s preerred measure o infation) measured bythe personal consumption defator excluding ood and energy prices, and
The unemployment rate.The orecasts are made by the entire FOMC (seven members o the Boardo Governors o the Fed, including Fed Chairman Bernanke) along with the
Ch – Ch – Ch – Changes…Time to Focus onthe Fed’s Forecasts
January 23, 2012
John Canally, CFA
EconomistLPL Financial
Plenty o changes likely to the FOMCstatement, but policy still on hold.The changing composition o the FOMC’svoting members will receive a great dealo media attention, but is not likely to alterpolicy in 2012.
Tuesday, January 24
Richmond FedJan
Wednesday, January 25
FOMC MeetingBernanke PressConerencePending Home Sales
Thursday, January 26
Durable Goods
Initial Claims
wk 1/21
New Home Sales
Leading Indicators
Friday, January 27
Real GDP
GDP Price Index
U o M ConsumerSentiment
Economic Calendar
LPL Financial Member FINRA/SIPC Page 2 o 5
presidents o each o the twelve Federal Reserve district banks (Boston,Chicago, New York, San Francisco, Dallas, etc.), not just the 12 votingmembers o the FOMC. The FOMC’s November 2011 orecast (see nearbytable) was generally more optimistic than the consensus orecast. At thetime we noted that even i the economy perormed in line with what theconsensus expected in 2012, the Fed would probably have to act to boostthe economy via additional monetary policy stimulus. Since November,the incoming economic data has been better than the consensus orecast,but generally in line with the Fed’s orecast. The one notable exceptionbeing the unemployment rate, which at 8.5% in December 2011, is alreadybelow the Fed’s orecast or late 2012 (8.6%). In short, we do not expectsubstantial upward revisions to the Fed’s already optimistic orecast.The Fed thinks (and most market participants generally agree) that bypublishing a orecast or the Fed unds rate that it sets, it will help to urtheranchor market expectations on interest rates and keep medium- and longer-term interest rates (rates that are infuenced by, but not set directly by, theFed) lower or longer. Lower rates, in turn, would help to spur consumerspending on durable goods like autos and televisions, and on housing aswell. Lower rates or longer would also likely spur more business spendingon capital equipment, actory expansion and hiring. Although most marketparticipants agree that by publishing its orecast or the Fed unds rate, theFed is being more transparent and thereby reducing market, consumer andbusiness uncertainty around the Fed’s intended path or interest rates, thereis some disagreement about the overall eect the published orecasts willhave on longer-term interest rates not directly set by the Fed.
Economic Projections o Federal Reserve Board Members and Federal Reserve Bank Presidents (%)
VariableCentral Tendency
Longer Run
Longer Run
Change in Real GDP1.6 1.72.5 2.93.0 3.53.0 3.92.4 2.71.6 1.82.3 3.52.7 4.02.7 4.52.2 3.0June Projection2.7 2.93.3 3.73.5 4.2N/A2.5 2.82.5 3.02.2 4.03.0 4.5N/A2.4 3.0Unemployment Rate9.0 9.18.5 8.77.8 8.26.8 7.75.2 6.08.9 9.18.1 8.97.5 8.46.5 8.05.0 6.0June Projection8.6 8.97.8 8.27.0 7.5N/A5.2 5.68.4 9.17.5 8.76.5 8.3N/A5.0 6.0PCE Ination2.7 2.91.4 2.01.5 2.01.5 2.01.7 2.02.5 3.31.4 2.81.4 2.51.5 2.41.5 2.0June Projection2.3 2.51.5 2.01.5 2.0N/A1.7 2.02.1 3.51.2 2.81.3 2.5N/A1.5 2.0Core PCE Ination
1.8 1.91.5 2.01.4 1.91.5 2.0N/A1.7 2.01.3 2.11.4 2.11.4 2.2N/AJune Projection1.5 1.81.4 2.01.4 2.0N/AN/A1.5 2.31.2 2.51.3 2.5N/AN/ASource: Federal Reserve November 2011Projections o change in real gross domestic product (GDP) and projections or both measures o ination are rom the ourth quarter o the previous year to the ourth quarter o theyear indicated. PCE ination and core PCE ination are the percentage rates o change in, respectively, the price index or personal consumption expenditures (PCE) and the price indexor PCE excluding ood and energy. Projections or the unemployment rate are or the average civilian unemployment rate in the ourth quarter o the year indicated. Each participant’sprojections are based on his or her assessment o appropriate monetary policy. Longer-run projections represent each participant’s assessment o the rate to which each variablewould be expected to converge under appropriate monetary policy and in the absence o urther shocks to the economy. The June projections were made in conjunction with themeeting o the Federal Open Market Committee on June 21 – 22, 2011.1. The central tendency excludes the three highest and three lowest projections or each variable in each year.2. The range or a variable in a given year includes all participants’ projections, rom lowest to highest, or that variable in that year.3. Longer-run projections or core PCE ination are not collected.
Since November, the incomingeconomic data has been better than theconsensus orecast, but generally in linewith the Fed’s orecast
LPL Financial Member FINRA/SIPC Page 3 o 5
Changing the Target
Turning now to the potential changes in the FOMC statement, nancialmarket participants generally expect the Fed to upgrade both its currentassessment o the economy and perhaps even elevate its outlook orgrowth and infation. As noted in the section above, our view is that theFed expected the economy to improve in 2011 and into 2012, and that it isunlikely to signicantly upgrade its outlook or the economy at this week’smeeting. The Fed is, however, likely to extend its promise to keep rates at“exceptionally low levels” beyond mid-2013, as was rst promised in August2011. The addition o a orecast or the Fed unds rate to the FOMC’sormal orecasts may make the promise to keep rates low within the FOMCstatement itsel a moot point.Some market participants anticipate that the FOMC statement may hintthat the Fed is mulling the possibility o targeting an infation rate, or eventargeting nominal GDP. While this FOMC meeting is a two-day meeting,which provides participants plenty o time to discuss such matters, in ourview, it is unlikely that these options would be included in the statementitsel at this meeting. A more likely scenario is that the minutes o thisweek’s FOMC meeting (due out in mid-February) will hint that eitherinfation targeting or GDP targeting was discussed, which would suggestthat they would likely become ormal components o Fed policymaking laterthis year.
Changing the Balance Sheet
Another item in the FOMC statement that market participants are targetingas a potential change rom the prior meeting is the size o the Fed’s balancesheet. Operation Twist (denition above) is set to expire in mid-2012, andin our view, it is probably too soon or the Fed to make the decision toextend the program or let it run its course. Some market participantsexpect the Fed to announce this week that it will begin yet another round oquantitative easing (the purchase o Treasury or mortgage-backed securitiesin the open market) to help keep rates lower or longer. We believe that iour orecast or the economy in 2012 (2.0% real GDP growth) is achieved,the Fed will certainty want to act to support the economy via another roundo quantitative easing.While the economic hurdle o implementing QE3 may be low, the politicalhurdles both within and outside the Fed remain high, which leaves only theFed’s communication policies as a viable alternative in the near term. I theFed is orced to do a third round o quantitative easing (QE3), recent publicstatements rom Fed ocials suggest that the Fed will target the mortgage-backed securities (MBS) market in an eort to encourage the still-strugglinghousing sector via lower rates and improved mortgage availability.Fed Chairman Bernanke’s press conerence on January 25 will be the ourthtime the Chairman has taken questions rom an audience o reportersollowing the FOMC meeting. With the market expecting several changesto the FOMC statement and to the FOMC’s orecast, the press conerencewill likely provide Bernanke with plenty o opportunities to clariy the Fed’s
While the economic hurdle oimplementing QE3 may be low, thepolitical hurdles both within and outsidethe Fed remain high, which leaves onlythe Fed’s communication policies as aviable alternative in the near term

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