Fed Watch: Bernanke's Balancing Act

BusinessWeek collects experts' views on what to expect from the Federal Reserve's June 23-34 policy meeting

By BusinessWeek Staff

Federal Reserve policy meetings no longer hold much suspense on the interest rate front—experts continue to believe that Ben Bernanke & Co. will be keeping the target range for the benchmark federal funds rate at 0% to 0.25% as the U.S. economy tries to regain its footing. But Wall Street will be watching carefully when the policy-setting Federal Open Market Committee releases the minutes of its two-day meeting on June 24 for clues about the Fed's views on the progress of the U.S. economic recovery, the inflation outlook, and whether the central bank will step up its purchases of Treasury debt to help keep interest rates in check.

What do Fed-watchers expect from the June 23-24 meeting? BusinessWeek compiled comments from Wall Street economists and strategists on June 22:

Michael Wallace, Action Economics

Even before the Fed accepts any new supervisory powers from Congress being negotiated by the Treasury, it still must prove it has a credible exit strategy from its exceptional liquidity efforts to smooth the stormy credit seas. The upcoming two-day FOMC meeting will serve to concentrate focus on any subtle changes to its extreme policy stance.

While a little more optimism may creep into the statement on normalization in the credit markets and growth recovery, and exit strategies will surely be hotly debated over the 48-hour period, members will certainly want to carefully navigate between incipient inflation risks and a premature conclusion of quantitative easing policy. At this early stage, any tightening signals or shifts from the 0%-0.25% fed funds target floor are likely to be left unarticulated, even while debated behind closed doors. Better to let the Fed's balance sheet unwind in a natural and methodical fashion for now. In fact, with mortgage rates on the way back up, the FOMC could be more inclined to temper rate hike speculation.

Brian Fabbri, BNP Paribas

Since the Fed's last FOMC [meeting] on Apr. 29, economic and financial conditions have continued to brighten, albeit, the improved conditions have led to the development of some potential impediments to future growth. The improvement in high frequency economic indicators has spread from consumer expectations and purchasing manager's surveys to some hard data indicators such as the peak and decline in new and continuing unemployment insurance claims and a substantial reduction in the number of payroll jobs lost in the latest survey month. This should reinforce the FOMC's confidence in their forecast that "sales and production would begin to recover in the second half of this year." This added confidence should be recognized in the first paragraph of their policy statement.

Signe Roed-Frederiksen, Danske Bank

The meeting will be a balancing act. On the one hand, there are members of the FOMC who fear that inflation expectations will run rampant unless the Fed states that it is ready with exit strategies. On the other hand, other members worry about the market's aggressive expectations for interest rate increases and the runup in Treasury and mortgage yields. We expect that the FOMC will sound more optimistic on economic outlook but at the same time stress that interest rates will be on hold for a prolonged period as inflationary pressure is expected to be absent for a long time to come.

Regarding alternative measures, we expect the FOMC to hold the overall size of purchase programs steady. However, it could choose to adopt a more flexible stance on the composition and the timing of the purchases. This would likely mean buying more Treasuries and less mortgage-related assets. It is difficult to predict the market reaction to such a complex statement but we prefer to be positioned for lower rates.

David Wyss and Beth Ann Bovino, Standard & Poor's

The Federal Reserve's attention remains on recession risk over inflation risk going into the June 23-24 FOMC meeting. No change in rates is likely, but Fed officials have expressed concern that the market is expecting a rate hike too soon (fourth quarter based on the futures market) and could include some language suggesting that no rate hike is likely for an extended period.

The Fed will have two-day FOMC meetings through the rest of 2009. Continued financial turmoil and the weak jobs report will likely keep the Fed on hold through most of 2010.

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