U.S. Fed More Confident in Economic Recovery, but Risks Remain and Progress Limited

The minutes of the December 14, 2010 Federal Open Market Committee (FOMC) meeting provided a slightly more upbeat assessment of the near-term outlook. Although given that the improvement was considered "modest", little change to the statement was deemed necessary, and the Fed remaining comfortable with the range of 0% to 0.25% for the fed funds target and keeping the program to buy $600 billion in U.S. Treasury bonds intact.

The minutes provided some detail on the Fed's view that the near-term outlook had improved somewhat relative to November. Production and household spending were mentioned as having strengthened, and the tone in the labour market was "a little better on balance". Policymakers said that the new fiscal package "was generally expected to support the pace of recovery next year." Still, the risks associated with developments in Europe, household and business deleveraging, businesses "reluctant" to hire and the depressed level of housing market activity could restrain growth going forward, policymakers said. Additionally, progress toward the Fed's mandate of full employment and price stability was considered "disappointingly slow".

While the statement clearly indicates the Fed's commitment to maintain all of its accommodative policy programs, some members suggested that the plans for the eventual unwinding of these policy measures should continue. Other members were cited as saying that "they had a fairly high threshold for making changes to the program" of asset purchases currently underway.

The minutes of the December meeting hammered home that the Fed still saw significant risks to the outlook and viewed the progress on inflation and employment as likely to remain slow even against a mildly improved outlook for growth. Our assessment is that recent economic reports indicate that the U.S. economy pulled out of the doldrums in the final quarter of 2010 with the growth rate forecasted to come in around 3.5%, which would be the fastest pace since the first quarter of 2010. Furthermore, we expect the economy's momentum to accelerate as the government's tax package bolsters consumer activity and businesses keep investing in capital goods. While the labour market has lagged the revival in activity, we anticipate that hiring will pick up its pace thereby resulting in a slow decline in the unemployment rate. Even with conditions improving, however, we see little chance of the Fed being in position to raise interest rates this year given the Fed's assessment that inflation will remain below the level consistent with its mandate "for some time". Rather, should the economy build momentum as expected, we look for the process of reducing policy stimulus to begin with the expiration of the asset purchase program, followed by the ending of the program to reinvest the proceeds of maturing holdings and eventually the sale of bonds held by the Fed. Assuming that the unwinding of these measures does not jar the economy from its stronger growth path, rate hikes are likely to follow in early 2012.

Source: ActionForex.Com