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Prefatory Note The attached document represents the most complete and accurate version available based on original copies culled from the files of the FOMC Secretariat at the Board of Governors of the Federal Reserve System. This electronic document was created through a comprehensive digitization process which included identifying the bestpreserved paper copies, scanning those copies, 1 and then making the scanned versions text-searchable. 2 Though a stringent quality assurance process was employed, some imperfections may remain. Please note that some material may have been redacted from this document if that material was received on a confidential basis. Redacted material is indicated by occasional gaps in the text or by gray boxes around non-text content. All redacted passages are exempt from disclosure under applicable provisions of the Freedom of Information Act. 1 In some cases, original copies needed to be photocopied before being scanned into electronic format. All scanned images were deskewed (to remove the effects of printer- and scanner-introduced tilting) and lightly cleaned (to remove dark spots caused by staple holes, hole punches, and other blemishes caused after initial printing). 2 A two-step process was used. An advanced optical character recognition computer program (OCR) first created electronic text from the document image. Where the OCR results were inconclusive, staff checked and corrected the text as necessary. Please note that the numbers and text in charts and tables were not reliably recognized by the OCR process and were not checked or corrected by staff. Content last modified 5/26/2009. Strictly Confidential (F.R.) Class II – FOMC June 19, 2003 M ONETARY POLICY ALTERNATIVES Recent Developments (1) The FOMC’s decision at its May meeting to keep the intended federal funds rate at 1¼ percent came as no surprise to most observers. By contrast, splitting the balance of risks into separate assessments about growth and inflation and emphasizing a concern about further declines of inflation from an already low level led market participants to mark down their policy expectations. The announcement also set the backdrop against which subsequent statements by Federal Reserve officials regarding the possibility of deflation and available policy alternatives were interpreted. Options on federal funds futures indicate that market participants are nearly certain of policy easing at this meeting, with a half-point cut given two-to-one odds over a quarter-point cut. Given the sense that Committee members have become more concerned about inflation turning out too low than too high, market participants now see a substantially longer period of low short-term interest rates; indeed, the funds rate is expected to remain below its current level through this year and most of next.1 (The box on the next page provides more detail on prevailing market expectations.) 1 The average effective federal funds rate for the intermeeting period came in close to 1.25 percent. The Desk purchased $4.5 billion of Treasury securities in outright operations: $2.1 billion of coupons in the market and $2.4 billion of bills from foreign official institutions. The outstanding amount of long-term RPs increased from $16 billion to $19 billion. 2 Policy Expectations In addition to marking down the expected path of policy over the intermeeting period, investors became more confident about their forecast for the funds rate (Chart 1). For example, based on options on eurodollar futures, the width of the 90 percent confidence interval around the expected target level one year ahead narrowed substantially over the period to stand at the lowest level in many years. A recently introduced options contract on federal funds futures on the Chicago Board of Trade opens a new window on market participants’ near-term policy outlook. Prices of options at different strikes depend on investors’ subjective probability assessment that the options will be in the money at expiration. The option-implied probability of no change in policy, the solid line in the bottom left panel, remained above 50 percent until June 3, but has since dropped nearly to zero. At last reading, these option-implied probabilities suggest that investors consider a half-point cut in the target rate about twice as likely as a quarter-point cut. Prices of options on Eurodollar futures can be used in a similar way to construct the probability distribution of the target rate later in the year, shown in the bottom-right panel. The most recent distribution (in red) has shifted markedly to the left and the weight on rates in the lower tail has been revised up significantly. Indeed, investors apparently place about a 15 percent probability on the funds rate trading at or below ½ percent in six months. (2) Consistent with a lower expected path for policy, yields on Treasury coupon securities shed 35 to 60 basis points over the intermeeting period, with much of the decline concentrated in implied forward rates at the three- to seven-year horizon (Chart 2). Inflation-indexed yields fell somewhat less, implying that inflation compensation declined moderately. The desire by managers of mortgage-backed security portfolios to extend the duration of their holdings, which has been shortened by the recent wave of mortgage refinancings, may have amplified the downward pressure on longer-term yields. With uncertainty about the future course of interest Chart 1 Policy Expectations Expected Federal Funds Rates* Percent 3.5 Uncertainty about Federal Funds Rates One Year Ahead* Basis Points 350 May 5 June 3 May 21 3.0 300 250 2.5 May 5, 2003 200 2.0 150 1.5 June 19, 2003 1.0 0.5 June Oct. 2003 Feb. June Oct. 2004 Feb. June 2005 Oct. 50 0 Jan. Feb. Mar. Apr. 2003 May June *Width of a 90 percent confidence interval computed from the term structures for the expected federal funds rate and implied volatility. Last observation is June 18, 2003. *Estimates from federal funds and eurodollar futures Probability of Policy Easing at the June FOMC Meeting from Federal Funds Option Prices* Percent 80 May 21 Chairman’s Testimony 100 Implied Distribution Five Months Ahead of Federal Funds Rate Derived from Eurodollar Option Prices* Percent June 3 Chairman’s Speech 40 60 June 19, 2003 May 5, 2003 35 30 25 40 20 50 bp Easing 15 10 20 No Change 25 bp Easing 5 0 0 5/6 5/16 5/28 2003 6/9 *Based on options on July 2003 federal funds futures. 6/19 0.25 0.50 0.75 1.00 1.25 1.50 1.75 2.00 2.25 2.50 2.75 3.00 *Estimates from options on eurodollar futures contracts, adjusted to estimate expectations for the federal funds rate. Chart 2 Financial Market Indicators Treasury Yield Curve* Percent Treasury Yields 7 6/19/2003 Day before FOMC meeting 5/5/2003 Percent 6 FOMC Daily Two-Year Treasury Ten-Year Treasury 6 5 5 4 4 3 3 2 2 1 1 0 1 3 5 7 10 20 30 Dec. 2002 Maturity in Years Jan. Feb. Mar. Apr. 2003 May June *Smoothed yield curve estimated from off-the-run Treasury coupon securities. Yields shown are those on notional par Treasury securities with semi-annual coupons. Higher-Tier Spreads Basis Points Lower-Tier Spreads 150 Daily Ten-Year AA - Ten-Year Treasury Ten-Year Swap - Ten-Year Treasury 120 Feb. Stock Prices Mar. Apr. 2003 May 1200 Daily 330 900 60 240 800 210 700 180 600 Dec. 2002 Index(12/31/02=100) Jan. Feb. Mar. Apr. 2003 May Implied Volatility - S&P100 (VIX) 130 Wilshire Nasdaq 1000 FOMC 270 June Daily 1100 Ten Year BBB - Ten-Year Treasury (left scale) Master II - Ten-Year Treasury (right scale) 90 30 Jan. Basis Points 300 FOMC Dec. 2002 360 June Percent 45 FOMC Daily 40 120 35 110 30 100 25 90 Dec. 2002 Jan. Feb. Mar. Apr. 2003 May June Dec. 2002 Jan. Feb. Mar. Apr. 2003 May June 3 rates reduced, term premia may have declined, adding to the drop in bond yields. (3) Yields on corporate bonds fell about in line with those on Treasuries even as capital markets absorbed a surge in issuance by highly-rated firms. Indeed, even lower-tier issuers found markets receptive, taking advantage of historically low bond yields to issue a record amount of debt in May. Stock price indexes registered sizable gains over the intermeeting period, buoyed by the decline in real yields as well as the improved outlook for economic growth and earnings and, perhaps, the cut in the tax rate on dividends and capital gains.2 (4) Since the May FOMC meeting, the dollar has slipped 3 percent further against an index of major foreign currencies (Chart 4). Contributing to the downward pressure were comments by U.S. Administration officials that were interpreted on balance as not opposing some depreciation of the dollar, and some heightening of longstanding concerns about the availability of international capital flows to finance the burgeoning U.S. current account deficit. The dollar declined 4½ percent against the Canadian dollar despite signs of slower activity in Canada. The dollar also dropped substantially against the euro, even as indicators pointed to lackluster domestic demand in the euro area and an increasing drag on its exports from the 2 Market attention focused for a time on Freddie Mac following the replacement of its top management in the wake of questions about its accounting practices. Freddie’s stock price has declined 15 percent since the shakeup (Chart 3). To reassure investors about the liquidity of its issues and to demonstrate its own financial health, Freddie conducted larger-than-usual buybacks of dollar- and eurodenominated debt. To date, however, there is little evidence that the increase in Freddie’s cost of funds is having a negative impact on secondary mortgage market activity. Although not implicated in any irregularities, Fannie Mae saw its stock decline in concert with Freddie M ac’s but by less. Although the fallout from this episode has been contained so far, credit default swap spreads show that market participants’ perception of Freddie’s riskiness as a counterparty has edged up despite the major rating agencies having reaffirmed the housing giant’s triple-A credit rating. Chart 3 Stock Prices Agency Debt Spreads to Ten-Year Treasury Index(1/3/02=100) Daily 50 Daily FOMC FOMC 115 Fannie Mae Freddie Mac Wilshire Basis Points Ten-Year Fannie Mae Ten-Year Freddie Mac 45 105 40 95 35 85 30 75 25 65 Jan. Apr. July 2002 Oct. Jan. Agency Mortgage-Backed Spreads to Ten-Year Treasury Apr. 2003 Dec. 2002 Basis Points FOMC Thirty-Year Fannie Mae Thirty-Year Freddie Mac Thirty-Year Ginnie Mae Feb. Mar. Apr. 2003 Credit Default Swap Spreads 130 Daily Jan. May June Basis Points 30 Daily FOMC 28 Fannie Mae Freddie Mac 120 26 110 24 100 22 90 20 80 18 70 16 60 Dec. 2002 Jan. Feb. Mar. Apr. 2003 May June Dec. 2002 Jan. Feb. Mar. Apr. 2003 May June Chart 4 International Financial Indicators Nominal Trade-Weighted Dollar Exchange Rates Index(1/28/02=100) Daily EMBI+ Index 110 Broad Major Currencies Other Important Trading Partners FOMC Basis Points FOMC Daily 2500 105 2000 100 Brazil 95 1500 90 1000 85 Overall 80 Sept. 2000 Feb. July 2001 Dec. May Oct. 2002 Commodity Prices 380 Mar. 2003 Feb. July 2001 Dec. May Oct. 2002 Mar. 2003 Custody Holdings at FRB-NY and Periods of Japanese Intervention $U.S. 40 Weekly 500 Sept. 2000 FOMC $Billions 960 Daily Jan. 15-29 Gold (left scale) Oil (right scale) Feb. 24 Mar. 10 May 8 Jun. 19 940 360 35 920 340 30 320 900 880 300 25 860 280 20 6* 260 Sept. 2000 Feb. July 2001 Dec. May Oct. 2002 Mar. 2003 Dec. 2002 Jan. 14* Feb. 840 37* Mar. Apr. 2003 May June *Total period purchases of U.S. dollars in billions by Japanese monetary authorities. 4 euro’s rebound over the past year. The economic slowdown and lower rates of inflation in the euro area have begun to stoke worries about deflation, especially in Germany where the economy has been stagnating. The ECB eased policy 50 basis points on June 5, as had been widely expected. The dollar was unchanged on balance against the yen, as market participants took note of extremely large purchases of dollars by Japanese authorities.3 The Bank of Japan raised its target somewhat for reserve balances and also announced a new program to purchase asset-backed securities. Yields on foreign long-term government securities moved down but, except for Canada, by less than in the United States. Foreign stock markets largely mirrored the continuing improvement in U.S. stock prices. (5) The dollar has been about unchanged on net since the May FOMC meeting against an index of the currencies of our other important trading partners, amid divergent movements against individual currencies. The dollar gained 3 percent against the Mexican peso, as Mexico reported an unexpectedly large contraction of GDP in the first quarter and signs of further weakness emerged. In contrast, the dollar lost ground against the Brazilian real, which strengthened 3½ percent, as financial markets continued to reward Brazil for achieving progress on key structural issues. Brazil’s EMBI+ spread narrowed about 75 basis points more to about 7¼ percentage points, and Brazilian stocks moved up another 5½ percent. Stock markets in several Asian economies–Taiwan, Hong Kong, Korea, Thailand–were buoyed by signs of recovery in the high-tech sector and indications that the impact of the SARS epidemic may be waning. (6) Households, businesses, and state and local governments continued to 3 . The Desk d id not intervene during the period for the accounts of the System or the Treasury. 5 take advantage of low longer-term yields in their funding. Net bond issuance by nonfinancial firms picked up over the period, but total borrowing remained fairly weak as businesses continued to pay down short-term debt (Chart 5). Despite the stock market rally, gross equity issuance recovered only marginally from the depressed levels of the preceding months, with initial public offerings remaining scarce. Data from commercial banks suggest that households continued to pile on mortgage debt as further declines in mortgage interest rates fueled a brisk pace of home purchases and another surge in refinancings. Borrowing by the state and local sector picked up, in part reflecting sizable advance refundings. With tax receipts running on the weak side and expenditures picking up, marketable Treasury borrowing surged, especially after the debt ceiling was raised. Given the extra impetus from the federal sector, domestic nonfinancial sector debt remained on track to expand at a considerably faster rate on balance in the second quarter than the 6½ percent pace registered in the first quarter. (7) The money stock expanded briskly in May. Even after accounting for estimated special factors boosting M2, including tax effects and mortgage refinancing activity, underlying growth was still quite strong. With M2 likely to grow at an 8 percent rate this quarter but nominal GDP growth shaping up to be 2½ percent, M2 velocity will most likely show a substantial decline even though opportunity costs have fallen only slightly. The decline in the overall cost of holding M2 masks substantial changes in relative returns on some components of the aggregate. In particular, the average yield on taxable retail money market mutual funds (the solid line in the lower left panel of Chart 5) has fallen to the point that those funds have lost their typical rate advantage to MMDAs offered by banks (the dotted line). Within the universe of money market mutual funds, as portrayed in the lower right panel, about 12 percent of assets are held by funds paying yields below ½ percent, suggesting that the scope for 6 continued large gross flows is considerable. Some of those funds, though, would likely shift to other money funds rather than to liquid deposits or out of the monetary aggregates if short rates were reduced further. 7 Policy Alternatives (8) Recent financial developments and the passage of a sizable tax cut over the intermeeting period have created a more supportive outlook for aggregate demand in the staff projection, but data on inflation have mostly run to the soft side of staff expectations. In the Greenbook, the staff now assumes that the FOMC will trim its target by ¼ percentage point and then subsequently keep it unchanged. At the same time, the level of stock prices has been raised and those of the dollar and long-term interest rates lowered in recognition of their respective net movements over the intermeeting period. The staff also has incorporated the greater fiscal stimulus embodied in the recently enacted tax cut than had been anticipated in the prior Greenbook. Thus, while incoming data have moved real GDP growth down a notch over the first half, real growth over the next six quarters has been raised nearly ½ percentage point--to 4¼ percent over the second half of 2003 and 5¼ percent over 2004. This faster advance in production is expected to speed the decline in the unemployment rate next year, which falls to 5.4 percent by late 2004. Given the generally lower-than-expected price data of late, core PCE inflation in the second quarter has been trimmed a bit, implying that four-quarter inflation by this measure will come in at 1 percent over this year. Core inflation is projected to edge down further in 2004, largely because slack in labor and product markets persists through next year. (9) The staff outlook presents a picture of an economy moving towards, but not yet attaining, equilibrium: While there is still some slack in labor markets, the growth of real GDP is above that of its potential, and both inflation and the real federal funds rate are at unusually low levels. To examine longer-term strategies for monetary policy as these dynamic imbalances adjust, three scenarios were created with the aid of the FRB/US model. The Greenbook forecast is extended through 2008 by 8 making several judgmental adjustments to the model that preserve the central features of the staff outlook. In particular, trend multifactor productivity is assumed to climb steadily at almost 1½ percent per year, which combined with a modest pickup in capital deepening from its current pace implies potential GDP is expanding at a roughly 3¾ percent rate later in the decade. The natural rate of unemployment remains close to 5 percent–the staff’s current long-run estimate. The unified federal budget is projected to settle into a deficit of about 2 percent of nominal GDP. The demand for U.S. exports is bolstered by 4 percent annual real depreciation of the dollar, as well as the gradual recovery of the world economy, so as to cap the current account deficit relative to nominal GDP at a little over 5 percent. (10) The dynamics of the FRB/US model have the property that, given the forces playing out in the staff forecast, the Committee has considerable time before it needs to realign the current unusually low real federal funds rate to its gradually rising equilibrium value. Three alternative simulations were run to examine the consequences for the economy and long-run inflation of varying degrees of delay in beginning the process of realigning the federal funds rate. In particular, these scenarios envision the consequences of moving the real funds rate to its long-run equilibrium level of about 2¾ percent relatively smoothly over the course of one year. The simulations differ according to when the Committee is assumed to start tightening–either 2005, 2006, or 2007. These simulations, shown in Chart 6, indicate, quite obviously, that the longer the Committee waits to tighten, the more will unemployment be worked down and inflation ultimately step up. Were policy to begin moving the real funds rate up in 2005, shown by the solid line in the upper left panel, the unemployment rate would stay close to 5 percent after 2004 (the middle panel), and core PCE inflation (the bottom panel) would settle around 3/4 percent. Delaying that process by one year–the dashed lines–or by two–the dotted lines–causes Chart 6 Alternative Simulations Real Federal Funds Rate 1 Nominal Federal Funds Rate Percent Pause until 2005 Pause until 2006 Pause until 2007 2001 2002 2003 2004 2005 2006 2007 2008 Percent 5 6 4 5 3 4 2 3 1 2 0 1 -1 0 -2 2001 2002 2003 2004 2005 2006 2007 2008 -1 Civilian Unemployment Rate Percent 6.5 6.0 5.5 5.0 4.5 4.0 2001 2002 2003 2004 2005 2006 2007 3.5 2008 PCE Inflation (ex. food and energy) (Four-quarter percent change) Percent 2.0 1.5 1.0 0.5 2001 2002 2003 2004 2005 2006 2007 2008 1. The real federal funds rate is calculated as the quarterly average nominal funds rate minus the four-quarter lagged core PCE inflation rate as a proxy for inflation expectations. 9 the unemployment rate to fall below 5 percent for a time and leads to higher inflation down the road, with growth in core PCE prices settling in at 1½ and 2 percent, respectively. (11) With regard to the immediate choice of policy, if the Committee both shares the staff assessment that prospective slack in resource use could foster disinflation and views the current inflation rate as already on the low side, it may favor a 25 basis point reduction in the intended federal funds rate. Such a policy move, by preserving much of the recent rally in financial markets, would provide support to aggregate demand, thereby helping to counter any tendency toward further substantial disinflation, which the Committee announced would be unwelcome in its statement after the May meeting. This benefit to the economy may be seen as coming at a low cost, in that an unwanted upsurge in inflation may be viewed as unlikely in an environment in which the level of output lies well below that of its estimated potential and inflation expectations remain subdued. Indeed, inflation expectations may have ticked lower of late, necessitating a moderate downward adjustment of the nominal rate to keep the real interest rate from rising. Should the action prove to be unnecessary, it could readily be unwound before any material harm is done. And even if inflation picked up a bit, the Committee might see that rise as desirable to increase the size of the cushion against the possibility of having to approach the zero bound on the nominal federal funds rate. Indeed, the alternative long-run scenarios suggest that the Committee may be able to hold the nominal funds rate near 1 percent for a considerable period of time without putting significant upward pressure on inflation. (12) Alternatively, the Committee may find the case for a 50 basis point cut in the funds rate to a level of 75 basis points to be persuasive. The Committee may wish to push harder against the persistent substantial output gap, which the staff has recently revised upward slightly to an estimated 2¾ percentage points of GDP in the 10 second quarter. As seen in Chart 7, with the real federal funds rate edging higher and some estimates of its equilibrium level moving lower, a 50 basis point easing may be seen as necessary merely to restore the degree of stimulus in place late last year. If the Committee thinks that the Greenbook is too optimistic about spending–perhaps because the effects of higher oil prices of late are underplayed–then it may be especially concerned about the chance of further disinflation as well. 4 Even if the Committee agrees with the Greenbook assessment of the economy, it may believe that the projected inflation rate would be uncomfortably low given the problems likely to emerge if the economy were to experience adverse shocks and the zero bound were to become an important constraint on policy. In this regard, the Committee may believe that a 50 basis point cut in the funds rate could be taken back later, if need be, at less cost to the economy than that potentially incurred by not moving now and increasing the difficulty of countering future economic weakness because the zero floor to the nominal funds rate became a binding constraint. (13) If the Committee is reasonably confident that underlying economic growth will turn out at least as strong as projected by the staff, it may view the consequences of an unchanged funds rate as the best that are feasible, given the lags with which monetary policy works. In fact, because the staff would forecast rapid GDP expansion over the next six quarters even with an unchanged funds rate, the Committee may view any policy easing at this meeting as risking excessive pressures on resources, exacerbating existing imbalances, or feeding an overshooting in financial markets. This concern could be especially pronounced if the Committee thinks that additional easing would probably induce faster economic growth or a lower 4 For an analysis of disinflation and deflation, see “Deflation, Low Inflation, and the Conduct of Monetary Policy,” a memorandum written by Douglas Elmendorf, Dave Reifschneider, and David Wilcox, which was sent to the FOMC on June 13, 2003. Chart 7 Actual Real Federal Funds Rate and Range of Estimated Equilibrium Real Rates Percent 5.5 Quarterly Actual Real Funds Rate 4.5 3.5 Historical Average: 2.68 (1966Q1-2003Q1) TIIS-Based Estimate 2.5 1.5 0.5 ● ● ● Current Rate 25 b.p. Easing 50 b.p. Easing -0.5 -1.5 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Note: The shaded range represents the maximum and the minimum values each quarter of four estimates of the equilibrium real federal funds rate based on a statistical filter and the FRB/US model. Real federal funds rates employ a four-quarter moving average of core PCE inflation as a proxy for inflation expectations, with the staff projection used for 2003Q2. Equilibrium Real Funds Rate Estimates (Percent) Statistical Filter - Two-sided: Based on historical data and the staff forecast May Bluebook 2001 ____ 2002 ____ 2003Q1 ______ ______ 2003Q2 1.1 0.4 0.4 0.5 1.0 0.2 0.1 0.2 - One-sided: Based on historical data* May Bluebook 2.2 0.7 -0.6 -0.5 2.2 0.6 -0.5 -0.5 FRB/US Model - Two-sided: Based on historical data and the staff forecast May Bluebook 2.1 1.5 1.1 1.0 2.2 1.6 1.3 1.3 - One-sided: Based on historical data** May Bluebook 2.0 0.8 0.1 -0.2 2.0 0.9 0.1 0.1 Treasury Inflation-Indexed Securities May Bluebook 3.9 3.5 3.1 3.0 3.9 3.5 3.1 3.3 * Also employs the staff projection for the current and next quarters. ** Also employs the staff projection for the current quarter. 11 unemployment rate than the staff foresees. Especially with the mounting fiscal stimulus evidently in train, the Committee may anticipate that a reduction in monetary accommodation will be called for in the not-too-distant future, and another ease at this meeting would make such a tightening action more sizable than otherwise. Instead, the Committee may wish to continue to await more readings on the economy collected after the Iraq war before reconsidering the need for any further easing action. 12 Directive and Assessment of Risks (14) From January 2000 to January 2003, the Committee summarized its views on the risks to the attainment of its goals of maximum sustainable economic growth and price stability in terms of a single sentence–the “balance-of-risks” assessment. In March, the Committee dropped this sentence from the press statement in light of the elevated uncertainties surrounding its outlook associated with the looming onset of war. The “balance-of-risks” language was refined in May, with the press release including a three-part assessment of the economy that characterized the risks individually surrounding the outlook for the growth of activity and inflation, as well as their joint consequences for the balance of risks to achieving the Committee’s goals. (15) The experience since the May 6 th announcement suggests that the three- part risk assessment served the Committee’s interests well, in that the public quickly came to understand the Federal Reserve’s concerns about additional disinflation without building alarm about the prospects for economic growth. By departing from the routinized words of the prior balance-of-risk statement, the three-point risk assessment was widely seen as meshing more effectively with the rest of the statement. Moreover, going forward, the three-part assessment would provide broader coverage of the range of possible outcomes for the economy than the earlier language, suggesting that the Committee would not be under pressure anytime soon to amend the form of the statement significantly. (16) While the Committee reviewed the wording of the release in advance of the policy vote in May, it formally voted on only the level of the intended federal funds rate, as will be noted in the minutes of that meeting to be released on Thursday, June 26th. In the past, the members of the Committee appear to have been satisfied with the practice of routinely reviewing the public announcement after the policy vote. 13 Assuming that the Committee would prefer to return to including an assessment of the risks to its outlook in its vote without reviewing the statement beforehand, it could opt to vote both on the directive and the three-part risk assessment presented below. To retain flexibility, the language of the assessment of risks below conveys the direction of each of the three parts without specifying the exact wording of the three relevant sentences of the announcement. (1) Directive Wording The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with maintaining/INCREASING/REDUCING the federal funds rate at/TO an average of around ___1-1/4 percent. (2) Risk Assessment The Committee desires that included in the official announcement released after the meeting (but not included in the directive) be the indications that, against the background of its long-run goals of price stability and sustainable economic growth and of the information currently available: The risks to its outlook for sustainable economic growth over the next several quarters [ARE WEIGHTED TOWARD THE DOWNSIDE] [are balanced] [ARE WEIGHTED TOWARD THE UPSIDE]; the risks to its outlook for inflation over the next several quarters [are weighted toward the downside] [ARE BALANCED] [ARE WEIGHTED TOWARD THE UPSIDE]; and, taken together, the balance of risks to its objectives [are weighted toward the downside] [ARE BALANCED] [ARE WEIGHTED TOWARD THE UPSIDE] in the foreseeable future. 14 Market Reaction and Monetary and Credit Aggregates (17) Under any of the three policy alternatives, the Committee may elect to retain the current structure and content of its assessment of the two component risks and their balance overall. It may again judge that equal risks of a shortfall or overshoot in real economic growth, combined with downside risks for inflation, would balance out overall risks to the downside for the foreseeable future. In addition to the assessment of the risks, market participants will pay close attention to the wording of the rest of the announcement, especially for any hints that the Committee considers the likelihood of deflation to be anything other than quite low. In that regard, some reports suggest the expectation that a 50 basis point move would be accompanied by an explanation of the Committee’s plan for the alternative implementation of policy, potentially including a rate target for a maturity longer than overnight. (18) With market participants predicting that an easing is likely at this meeting and that a reduction of 50 basis points is more probable than one of 25 basis points, the market reaction would be most pronounced if the FOMC were to decide to stay on hold. Given that the outlook for corporate earnings with an unchanged funds rate would be less buoyant than market participants expect, a stock price decline would follow such a decision. Unless this decline were quite large, some backup in long-term interest rates would likely be associated with the sizable rise in short-term interest rates. An easing move of 25 basis points would have some of these effects, albeit more muted. By contrast, a 50 basis point reduction would be larger than expected and could induce initial increases in stock and bond prices. Such a cut could cause financial distress for some higher-cost money market mutual funds and also might begin to raise market concerns about the remaining scope for further conventional monetary policy stimulus. Indeed, longer-term Treasuries might be bid up in price 15 over time as market participants come increasingly to anticipate large-scale purchases by the Federal Reserve. (19) The Greenbook assumption of a 25 basis point easing, combined with its projection of nominal GDP growth at a 5 percent rate over the second half of this year, probably would induce M2 growth of 7½ percent over the same period. The implied decline in M2 velocity of 2½ percent follows an estimated drop of 4 percent over the first half of this year. On a period-end basis, domestic nonfinancial debt is expected to expand at a pace of 7½ percent over the second half of this year. The federal debt component would grow at an annual rate of 10½ percent, and nonfederal sector debt is projected to record a growth rate of 6¾ percent over the next two quarters, paced by the expansion of home mortgage debt. Alternative Growth Rates for M2 Ease 50 bp Ease 25 bp* No change Monthly Growth Rates Jan-03 Feb-03 Mar-03 Apr-03 May-03 Jun-03 Jul-03 Aug-03 Sep-03 Oct-03 Nov-03 Dec-03 6.1 11.3 2.8 4.7 17.5 6.2 6.7 7.4 8.1 8.3 7.9 7.4 6.1 11.3 2.8 4.7 17.5 6.2 6.3 6.6 7.3 7.6 7.4 7.0 6.1 11.3 2.8 4.7 17.5 6.2 6.0 5.8 6.5 6.9 6.9 6.6 Quarterly Growth Rates 2003 Q1 2003 Q2 2003 Q3 2003 Q4 6.5 8.1 8.1 8.0 6.5 8.1 7.7 7.4 6.5 8.1 7.3 6.7 Semiannual Growth Rates 2003 H1 2003 H2 7.4 8.2 7.4 7.6 7.4 7.1 Annual Growth Rates 2002 2003 6.8 7.9 6.8 7.6 6.8 7.3 Growth Rates From To 2002 Q4 May-03 2002 Q4 Dec-03 8.0 7.9 8.0 7.6 8.0 7.3 8.6 7.6 8.6 7.0 8.6 6.5 Dec-02 May-03 May-03 Dec-03 * Consistent with the Greenbook forecasts for nominal GDP and interest rates. SELECTED INTEREST RATES (percent) Short-term Treasury bills secondary market Federal funds 1 Long-term CDs secondary market Comm. paper Off-the-run Treasury yields Indexed yields Moody’s Baa Municipal Bond Buyer Conventional home mortgages primary market 4-week 3-month 6-month 3-month 1-month 2-year 5-year 10-year 30-year 5-year 10-year Fixed-rate ARM 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 02 -- High -- Low 1.92 1.15 1.82 1.07 1.88 1.16 2.16 1.23 1.98 1.31 1.81 1.26 3.75 1.59 4.99 2.72 5.73 3.94 6.04 4.85 3.33 1.59 3.56 2.13 8.23 7.30 5.67 5.02 7.18 5.93 5.26 4.01 03 -- High -- Low Monthly Jun 02 02 Jul Aug 02 Sep 02 Oct 02 Nov 02 Dec 02 1.38 1.12 1.26 0.83 1.22 0.81 1.28 0.82 1.32 0.93 1.28 1.00 1.89 1.09 3.24 2.06 4.45 3.29 5.28 4.37 1.81 0.59 2.43 1.41 7.48 6.01 5.20 4.78 5.97 5.21 4.03 3.51 1.75 1.73 1.74 1.75 1.75 1.34 1.24 1.71 1.72 1.68 1.67 1.62 1.26 1.20 1.73 1.71 1.65 1.66 1.61 1.25 1.21 1.83 1.74 1.64 1.64 1.59 1.30 1.27 1.81 1.79 1.73 1.76 1.73 1.39 1.34 1.74 1.74 1.72 1.73 1.72 1.34 1.31 2.97 2.52 2.12 1.98 1.92 1.94 1.84 4.24 3.86 3.37 3.01 3.02 3.13 3.09 5.16 4.90 4.54 4.16 4.25 4.33 4.31 5.71 5.60 5.27 4.97 5.13 5.16 5.12 2.46 2.39 2.11 1.80 1.90 2.00 1.89 3.08 2.92 2.51 2.25 2.40 2.44 2.41 7.95 7.90 7.58 7.40 7.73 7.62 7.45 5.44 5.34 5.30 5.10 5.16 5.25 5.20 6.65 6.49 6.29 6.09 6.11 6.07 6.05 4.65 4.51 4.38 4.29 4.27 4.16 4.12 03 03 03 03 03 1.24 1.26 1.25 1.26 1.26 1.17 1.20 1.18 1.16 1.08 1.19 1.19 1.15 1.15 1.09 1.22 1.20 1.16 1.17 1.10 1.29 1.27 1.23 1.24 1.22 1.25 1.24 1.21 1.22 1.21 1.76 1.64 1.59 1.65 1.41 3.07 2.92 2.81 2.94 2.53 4.30 4.14 4.04 4.16 3.74 5.14 5.01 4.98 5.07 4.70 1.64 1.21 1.03 1.27 1.06 2.26 1.95 1.88 2.12 1.83 7.35 7.06 6.95 6.85 6.38 5.19 5.15 5.12 5.17 4.92 5.92 5.84 5.75 5.81 5.48 3.99 3.86 3.76 3.80 3.66 Jan Feb Mar Apr May Weekly Apr Apr May May May May May Jun Jun Jun Daily Jun Jun Jun Jun Jun Jun Jun Jun Jun Jun Jun Jun Jun 18 25 2 9 16 23 30 6 13 20 03 03 03 03 03 03 03 03 03 03 1.27 1.26 1.28 1.26 1.27 1.24 1.26 1.25 1.24 -- 1.16 1.14 1.11 1.08 1.00 1.09 1.19 1.15 1.06 0.90 1.18 1.16 1.13 1.11 1.07 1.06 1.11 1.07 0.94 0.87 1.21 1.19 1.16 1.14 1.10 1.07 1.09 1.05 0.93 0.88 1.26 1.26 1.24 1.23 1.23 1.21 1.22 1.18 1.05 0.97 1.21 1.23 1.22 1.20 1.22 1.21 1.23 1.21 1.10 1.00 1.72 1.68 1.58 1.48 1.42 1.34 1.32 1.26 1.14 1.22 2.99 2.98 2.89 2.70 2.52 2.37 2.34 2.28 2.13 2.26 4.19 4.17 4.10 3.95 3.73 3.56 3.57 3.53 3.37 3.47 5.10 5.05 4.99 4.89 4.71 4.50 4.54 4.57 4.45 4.51 1.28 1.37 1.30 1.16 1.05 0.94 0.97 0.88 0.67 0.78 2.14 2.18 2.11 1.98 1.82 1.67 1.71 1.67 1.50 1.61 6.89 6.79 6.68 6.52 6.39 6.23 6.24 6.22 6.08 -- 5.16 5.11 5.09 5.01 4.88 4.82 4.82 4.83 4.78 -- 5.82 5.79 5.70 5.62 5.45 5.34 5.31 5.26 5.21 5.21 3.79 3.79 3.74 3.66 3.67 3.61 3.63 3.59 3.54 3.51 3 4 5 6 9 10 11 12 13 16 17 18 19 03 03 03 03 03 03 03 03 03 03 03 03 03 1.21 1.22 1.26 1.24 1.25 1.22 1.25 1.25 1.24 1.33 1.24 1.22 -- 1.17 1.15 1.12 1.15 1.16 1.10 1.07 1.03 0.93 0.94 0.93 0.91 0.83 1.08 1.05 1.04 1.05 1.03 0.97 0.94 0.92 0.86 0.87 0.90 0.89 0.81 1.05 1.03 1.03 1.03 1.00 0.95 0.95 0.90 0.86 0.88 0.91 0.89 0.82 1.21 1.18 1.16 1.12 1.11 1.10 1.02 1.02 0.99 0.96 0.97 1.00 0.93 1.23 1.21 1.21 1.19 1.14 1.14 1.11 1.06 1.05 1.00 1.00 1.01 -- 1.22 1.20 1.25 1.27 1.19 1.12 1.16 1.11 1.09 1.17 1.24 1.27 1.18 2.25 2.20 2.26 2.30 2.21 2.12 2.15 2.10 2.06 2.15 2.26 2.35 2.28 3.51 3.47 3.52 3.54 3.46 3.37 3.39 3.35 3.29 3.36 3.44 3.54 3.53 4.54 4.53 4.58 4.59 4.54 4.46 4.45 4.41 4.37 4.41 4.48 4.56 4.59 0.89 0.83 0.83 0.86 0.76 0.68 0.69 0.65 0.59 0.69 0.79 0.86 0.76 1.67 1.63 1.65 1.66 1.59 1.51 1.51 1.48 1.41 1.49 1.59 1.69 1.68 6.22 6.17 6.21 6.20 6.16 6.09 6.08 6.06 6.01 6.05 6.12 6.20 -- -------------- -------------- -------------- NOTE: Weekly data for columns 1 through 13 are week-ending averages. Columns 2 through 4 are on a coupon equivalent basis. Data in column 6 are interpolated from data on certain commercial paper trades settled by the Depository Trust Company. Column 14 is the Bond Buyer revenue index, which is a 1-day quote for Thursday. Column 15 is the average contract rate on new commitments for fixed-rate mortgages (FRMs) with 80 percent loan-to-value ratios at major institutional lenders. Column 16 is the average initial contract rate on new commitments for 1-year, adjustable-rate mortgages (ARMs) at major institutional lenders offering both FRMs and ARMs with the same number of discount points. MFMA Strictly Confidential (FR)Class II FOMC Money Aggregates Seasonally adjusted nontransactions components M1 Period M2 M3 In M2 1 4 5 Annual growth rates(%): Annually (Q4 to Q4) 2000 2001 2002 -1.7 6.8 3.3 6.1 10.2 6.8 8.5 11.2 7.7 17.3 18.5 5.4 9.2 12.7 6.3 Quarterly(average) 2002-Q2 Q3 Q4 2003-Q1 -0.6 3.0 4.9 7.4 3.8 8.8 7.0 6.5 5.0 10.4 7.6 6.3 4.4 3.8 9.2 2.1 4.0 7.2 7.7 5.1 10.9 5.7 7.0 -11.2 6.9 11.4 -0.5 8.2 13.6 6.5 10.3 8.1 5.4 8.0 8.3 3.1 14.4 6.7 11.2 13.3 5.1 7.0 10.7 1.8 -0.7 1.9 -0.6 12.9 7.0 -12.4 37.9 17.7 9.1 5.0 6.8 9.6 5.9 1.5 17.6 7.8 2.5 20.0 3.3 0.4 20.3 6.1 11.3 2.8 4.7 17.5 7.1 8.9 2.7 5.8 16.8 -14.4 -6.2 3.0 -4.6 3.2 -0.5 5.7 2.9 1.8 13.1 1213.6 1233.8 1237.2 1237.6 1258.5 5821.4 5876.1 5890.0 5913.0 5999.3 4607.9 4642.2 4652.8 4675.4 4740.8 2694.3 2680.3 2686.9 2676.6 2683.8 8515.7 8556.4 8576.9 8589.6 8683.1 1254.3 1249.8 1261.9 1269.6 5983.8 5993.6 6003.3 6011.1 4729.5 4743.8 4741.3 4741.6 2679.5 2686.0 2680.3 2686.5 8663.3 8679.6 8683.5 8697.6 1261.5 1260.2 6020.6 6021.4 4759.0 4761.2 2686.7 2678.9 8707.3 8700.3 Monthly 2002-May June July Aug. Sep. Oct. Nov. Dec. 2003-Jan. Feb. Mar. Apr. May p Levels ($billions): Monthly 2003-Jan. Feb. Mar. Apr. May p Weekly 2003-May June p 3 2 In M3 only preliminary 5 12 19 26 2p 9p 81 354 280 348 692 115 539 207 326 16 Apr 23 Apr 30 May 7 May 14 May 21 May 28 Jun 4 Jun 11 Jun 18 2003 Jun 19 May 6-Jun 19 --- --- --- ----- ----- ----- ----- ----- ----- ----- ----- --- --- ----- --- --- ----- --- --- Net 238.8 2,453 16 326 539 207 692 115 280 348 81 354 2,843 264 387 564 3,543 1,684 4,161 1,863 --- --- --250 6,024 250 8,227 6,117 6,827 21,421 -15,846 5,408 Change 106.3 786 --- --- ----- 786 --- ----- ----- --1,422 ----- 1,422 786 478 1,318 --- --- ----- 1,796 --- 5,535 2,835 4,349 12,720 8,809 15,663 <1 180.2 1,057 --- --- ----- 1,057 --- ----- ----- 733 --- ----- 733 1,057 2,127 710 --- 339 ----- 2,837 339 2,580 3,676 6,153 12,748 14,482 22,814 1-5 46.7 234 --- --- ----- 234 --- ----- ----- ----- 522 --- --234 769 522 --- 314 ----- 1,291 314 2,471 1,318 971 5,074 5,871 6,003 5-10 Net Purchases 3 4. 5. 6. 7. --- --- --- ----- ----- ----- ----- ----- ----- ----- ----- --- --- ----- --- --- ----- --- --- 3,779 16,802 Redemptions (-) 413.2 2,077 --- --- ----- 2,077 --- ----- ----- 733 1,422 572 --- 2,155 2,077 3,374 2,600 --- 653 ----- 5,974 653 10,796 7,972 13,401 32,822 31,215 36,208 Net Change 0.0 --- --- --- ----- ----- ----- ----- ----- ----- ----- ----- --- --- ----- --- --- ----- --- --- 51 120 652.0 4,530 16 326 539 207 2,768 115 280 348 81 354 3,576 1,686 959 564 5,699 3,761 7,534 4,463 --- 653 --250 11,998 903 19,023 14,089 20,228 54,242 15,318 41,496 outright holdings 4 total Agency Redemptions (-) Net change Federal Includes redemptions (-) of Treasury and agency securities. RPs outstanding less reverse RPs. Original maturity of 15 days or less. Original maturity of 16 to 90 days. 80.0 --- --- --- ----- ----- ----- ----- ----- 50 --- ----- --50 --- --- ----- 50 --- 210 143 1,927 2,280 5,833 8,531 Over 10 Treasury Coupons -18.5 -2,369 391 -754 -5,433 -3,357 -2,810 7,067 -8,590 4,791 -1,735 5,460 -7,933 4,836 -5,733 6,207 -265 -515 1,736 -2,254 1,342 -1,097 2,779 2,910 1,957 4,892 -2,644 -3,067 -1,961 -5,366 -2,163 3,492 ShortTerm 6 19.0 2,999 --- --- 1,000 --- 2,000 -1,001 --1,000 -1,000 -999 ----- --2,000 816 346 -2,262 520 -3,581 10,706 -4,716 4,616 3,770 -304 -4,563 -5,225 -2,191 517 7,133 636 LongTerm 7 Net RPs 5 MRA:HRM 0.5 630 391 -754 -4,433 -3,357 -810 6,066 -8,590 5,791 -2,735 4,461 -7,933 4,836 -5,733 8,207 551 -170 -526 -1,734 -2,239 9,610 -1,937 7,526 5,727 4,588 -7,207 -8,291 -4,152 -4,850 4,970 4,128 Net Change Class II FOMC (Millions of dollars, not seasonally adjusted) 1. Change from end-of-period to end-of-period. Excludes changes in compensation for the effects of inflation on the principal of inflation-indexed securities. 2. Outright purchases less outright sales (in market and with foreign accounts). 3. Outright purchases less outright sales (in market and with foreign accounts). Includes short-term notes acquired in exchange for maturing bills. Excludes maturity shifts and rollovers of maturing issues, except the rollover of inflation compensation. Memo: LEVEL (bil. $) Jun 19 2,453 2,843 264 Apr 9 Apr 16 Intermeeting Period 387 564 3,543 1,684 Apr May 2003 Mar 26 Apr 2 --- 4,161 1,863 --- Dec Feb Mar --250 2002 Oct Nov 2003 Jan 6,024 2003 QI 250 QIV 6,827 8,227 6,117 QII QIII 2002 QI 21,421 2002 24,522 10,095 (-) 8,676 15,503 Redemptions Net Treasury Bills Purchases 2 2000 2001 June 19, 2003 Strictly Confidential Changes in System Holdings of Securities 1
@FedFRASER