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FOMC Meeting Transcript, September 20-21, 2011

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FOMC Meeting Transcript, September 20-21, 2011 September 20–21, 2011 1 of 290 Meeting of the Federal Open Market Committee on September 20–21, 2011 A joint meeting of the Federal Open Market Committee and the Board of Governors of the Federal Reserve System was held in the offices of the Board of Governors in Washington, D.C., starting on Tuesday, September 20, 2011, at 10:30 a.m., and continuing on Wednesday, September 21, 2011, at 9:00 a.m. Ben Bernanke, Chairman William C. Dudley, Vice Chairman Elizabeth Duke Charles L. Evans Richard W. Fisher Narayana Kocherlakota Charles I. Plosser Sarah Bloom Raskin Daniel K. Tarullo Janet L. Yellen Christine Cumming, Jeffrey M. Lacker, Dennis P. Lockhart, Sandra Pianalto, and John C. Williams, Alternate Members of the Federal Open Market Committee James Bullard and Eric Rosengren, Presidents of the Federal Reserve Banks of St. Louis and Boston, respectively Esther L. George, First Vice President, Federal Reserve Bank of Kansas City William B. English, Secretary and Economist Deborah J. Danker, Deputy Secretary Matthew M. Luecke, Assistant Secretary David W. Skidmore, Assistant Secretary Michelle A. Smith, Assistant Secretary Scott G. Alvarez, General Counsel Thomas C. Baxter, Deputy General Counsel James A. Clouse, Thomas A. Connors, Steven B. Kamin, Loretta J. Mester, Simon Potter, David Reifschneider, Harvey Rosenblum, and David W. Wilcox, Associate Economists Brian Sack, Manager, System Open Market Account Jennifer J. Johnson, Secretary of the Board, Office of the Secretary, Board of Governors Patrick M. Parkinson, Director, Division of Banking Supervision and Regulation, Board of Governors September 20–21, 2011 2 of 290 Nellie Liang, Director, Office of Financial Stability Policy and Research, Board of Governors Robert deV. Frierson, Deputy Secretary, Office of the Secretary, Board of Governors William Nelson, Deputy Director, Division of Monetary Affairs, Board of Governors Linda Robertson, Assistant to the Board, Office of Board Members, Board of Governors Charles S. Struckmeyer, Deputy Staff Director, Office of the Staff Director, Board of Governors Seth B. Carpenter, Senior Associate Director, Division of Monetary Affairs, Board of Governors; Michael P. Leahy, Senior Associate Director, Division of International Finance, Board of Governors; Lawrence Slifman and William Wascher, Senior Associate Directors, Division of Research and Statistics, Board of Governors Andrew T. Levin, Senior Adviser, Office of Board Members, Board of Governors; Stephen A. Meyer and Joyce K. Zickler, Senior Advisers, Division of Monetary Affairs, Board of Governors Daniel M. Covitz and David E. Lebow, Associate Directors, Division of Research and Statistics, Board of Governors David H. Small, Project Manager, Division of Monetary Affairs, Board of Governors Penelope A. Beattie, Assistant to the Secretary, Office of the Secretary, Board of Governors .. James M. Lyon, First Vice President, Federal Reserve Bank of Minneapolis Jeff Fuhrer, Executive Vice President, Federal Reserve Bank of Boston David Altig, Alan D. Barkema, Spencer Krane, Mark E. Schweitzer, Christopher J. Waller, and John A. Weinberg, Senior Vice Presidents, Federal Reserve Banks of Atlanta, Kansas City, Chicago, Cleveland, St. Louis, and Richmond, respectively Julie Ann Remache, Assistant Vice President, Federal Reserve Bank of New York Eric T. Swanson, Senior Research Advisor, Federal Reserve Bank of San Francisco Jonathan Heathcote, Senior Economist, Federal Reserve Bank of Minneapolis September 20–21, 2011 3 of 290 Transcript of the Federal Open Market Committee Meeting on September 20–21, 2011 September 20 Session CHAIRMAN BERNANKE. Good morning, everybody. This is a joint meeting of the Federal Open Market Committee and the Board. I need a motion to close the meeting. MS. YELLEN. So moved. CHAIRMAN BERNANKE. Thank you. Let me start by welcoming Esther George to the table. Tom Hoenig is still president of the Federal Reserve Bank of Kansas City for another 10 days, and so officially you’re representing the Bank as first vice president, but at the next meeting, you will, of course, be succeeding Tom. You’re well known to everyone around the table. You’ve been in the System a long time, and you have a great deal of high regard. So again, welcome and congratulations. MS. GEORGE. Thank you. CHAIRMAN BERNANKE. Our first item is “Financial Developments in Open Market Operations.” Let me turn it over to Brian Sack. MR. SACK.1 Thank you, Mr. Chairman. Financial markets continue to be strongly influenced by concerns about economic growth prospects for the U.S. and other advanced economies, as well as perceptions of substantial risks surrounding the European sovereign debt situation. These factors led to considerable volatility in the prices of risky assets, large declines in interest rates, notable strains in short-term funding markets for some financial institutions, and greater market expectations that the Federal Reserve will deliver additional policy accommodation. Although U.S. interest rates had already reached quite low levels at the time of the August FOMC meeting, they declined further over the intermeeting period. As shown in the upper-left panel of your first exhibit, the expected path for the federal funds rate derived from overnight index swaps now reflects an even later liftoff from the near-zero range. Much of the downward shift in policy expectations came in response to the August FOMC statement, which indicated that the Committee expects economic 1 The materials used by Mr. Sack are appended to this transcript (appendix 1). September 20–21, 2011 4 of 290 conditions to warrant exceptionally low levels of the federal funds rate at least through mid-2013. That statement prompted implied short-term interest rates two years ahead to shift down by about 25 basis points, as investors interpreted the statement as indicating a lower probability that the federal funds rate target would rise before that time. Consistent with that interpretation, measures of implied volatility for interest rates around that horizon also declined notably in response to the FOMC statement. Additional evidence on the change in investors’ expectations is provided by the Desk’s primary dealer survey. As shown in the upper-right panel, the perceived chances of the first increase in the federal funds rate target occurring before the third quarter of 2013 fell significantly, partly reflecting the forward policy guidance from the August FOMC statement. However, respondents still attached about 20 percent odds to the possibility that the first rate hike could occur before mid-2013, indicating that investors do not see the policy language as an unconditional commitment. Instead, market participants reportedly see the policy guidance as “raising the bar” for policy action before that time. The sense that the federal funds rate target will remain at its current level for a long period was reinforced by the incoming economic data, which pointed to an economy struggling to find its footing. Indeed, since the last FOMC round, primary dealers slashed their GDP forecasts by roughly ½ percentage point per year for the period from 2011 to 2013 and raised their projections for the unemployment rate at the end of 2013 by nearly ¾ of a percentage point. Moreover, dealers see the uncertainty surrounding the GDP outlook as unusually high and view the risks as skewed to the downside. Against this backdrop, Treasury yields moved down notably, as shown in the middle-left panel, with the largest declines in longer-term yields. The movement in longer-term yields was partly driven by increased expectations that the FOMC will implement some type of maturity extension program for the SOMA portfolio—one that would involve sizable purchases of longer-term securities. As I will review in detail later, market participants are now placing very high odds on such a move at this FOMC meeting. At this point, longer-term real interest rates have reached extraordinarily low levels. Indeed, as shown to the right, the 10-year TIPS yield has been hovering around zero, which is well below its historical range. An alternative measure of the real long-term interest rate based on the difference between the 10-year nominal Treasury yield and a survey measure of long-term inflation expectations is also near zero, which is again quite unusual relative to its historical norms. In my previous briefing, I noted that forward breakeven inflation rates had remained relatively high even as real interest rates had declined, suggesting that longer-term inflation expectations were well anchored. While that still appears to be true in general, there are some signs that those expectations are coming under downward pressure. As shown in the bottom-left panel, the five-year, five-year September 20–21, 2011 5 of 290 forward breakeven inflation rate fell notably over the intermeeting period, moving about halfway back to the levels seen last summer. Moreover, as shown to the right, measures of the perceived odds of a sustained deflation derived from TIPS have risen some. Investors’ concerns about economic growth prospects weighed on financial markets more broadly, contributing to considerable volatility in risky asset prices and a general sense of unease among market participants. The negative sentiment in markets was exacerbated by the substantial risks that investors see surrounding the situation for European sovereign debt and financial institutions. Broad equity indexes, shown in the upper-left panel of your second exhibit, managed to move higher over the intermeeting period. However, these gains come on the heels of the very steep declines that were observed ahead of the August meeting, leaving the S&P index still about 10 percent below its levels in July. Moreover, as shown to the right, the volatility of daily changes in equity prices was the highest observed since early 2009, and measures of anticipated volatility, such as the VIX, have also been elevated. Returning to the upper-left panel, the downward movement in equity prices over the past several months has been particularly sharp for financial institutions.
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