Following a discount rate decision, the Federal Open Market Committee (FOMC) always issues a press release, and the press release always follows a very standard format. There are usually six paragraphs and the language from one press release to the next is extremely similar - cut and paste, some might suggest. This presents an opportunity, as careful examination of the subtle changes in a new announcement versus the old ones can reveal where the FOMC thinks the economy is headed.
Follow along as we deconstruct the recent FOMC statement from Wednesday and compare it to the previous statement in April to uncover whether the FOMC is changing its tune.
Paragraph 1: Rate Decision - Keep it Simple
|June: "The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent."
April: "The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2 percent."
For both announcements, the first sentence directly states the FOMC's decision on rates. The language is clear, so as to allow Wall Street quick access to necessary rate specific information. As you will note, the FOMC held rates steady on Tuesday at 2%, versus the 25 basis-point cut in April, bringing the fed funds rate to the present 2%.
Paragraph 2: Present State of Affairs - A Conspicuous Language Change
June: "Recent information indicates that overall economic activity continues to expand, partly reflecting some firming in household spending. However, labor markets have softened further and financial markets remain under considerable stress. Tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters." [emphasis mine]
April: "Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters." [emphasis mine]
The FOMC changed the language of the "present state of affairs" for the June announcement to indicate that economic conditions are improving. In the third sentence, there is a subtle change in language regarding housing. You will notice the word "deepening" has been replaced by "ongoing." The very important point to note here is that housing may actually be on the eve of recovery. This one subtle shift indicates that the FOMC is not seeing further substantial downside in U.S. housing markets. (Learn about the tools the Fed uses to influence interest rates and general economic conditions, in our related article Formulating Economic Policy.)
Paragraph 3: Inflation - Same Problem, Different Reasons
June: "The Committee expects inflation to moderate later this year and next year. However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high." [emphasis mine]
April: "Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully." [emphasis mine]
The June statement's language was similar to that of the April statement, thus showing us that the FOMC has not changed it's view on inflation. Elevated inflation in the short term could demand a rate hike, which would be bad for stocks. Thus, over July and August, we will want to watch Consumer Price Index as an indication of a potential hike in September. A hike this fall could cause stocks to decline. (Find out how this figure relates to your investment portfolio, in What You Should Know About Inflation and Economic Indicators To Know.)
Paragraph 4: Monetary Policy - Recovery = Rate Hike
June: "The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time. Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability." [emphasis mine]
April: "The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability."
With the exception of a single sentence, the June statement is virtually identical to April's. Unfortunately the additional sentence does not offer much new, as both statements boil down to the FOMC saying: "Look, we've given you a pile of money, and when the moment is right we're going to take it back." Investors need to be aware that once the economy is stable again, the FOMC wants to hike rates.
Paragraph 5: Voting Record - Fisher Stands Alone
|June: Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred an increase in the target for the federal funds rate at this meeting. [emphasis mine]
April: Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred no change in the target for the federal funds rate at this meeting. [emphasis mine]
Fisher has been voting for a hike, or no cuts since January; he's very hawkish overall. Only once in 2008 has another Fed president voted with him. In April, Charles Plosser voted for no change in the fed funds rate. What does this mean? Whenever you see that Fisher is about to speak to the press, expect overly hawkish comments, which are good for the U.S. dollar but bad for stocks.
Paragraph 6 - Changes to the discount rate
June: No sixth paragraph.
April: In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 2-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Atlanta, and San Francisco.
There was no sixth paragraph in June's statement, as there were no alterations to the discount rate. When the discount rate is lowered, banks have greater access to money. For now, the FOMC believes liquidity is self-sustaining, hence the absence of the sixth paragraph. Overall, what we need to consider here is that the FOMC believes the economy is recovering, and that we are on the right track, although some risks remain.
The largest change in the statement was also one of the most subtle. Many in the media missed the change in the language regarding housing markets. The rest of the press release shows us that the FOMC doesn't shy away from repeating a previous phrase verbatim, so any change is noteworthy. Clearly, the FOMC sees enough liquidity returning, and improvement in the credit market that a change in language was warranted.
This means we could near the bottom in housing markets. Using the FOMC statement as guidance, it's probably time to begin looking for buy entry points on quality housing stocks. Possible names include Lennar (NYSE:LEN), KB Home (NYSE:KBH), Pulte Homes (NYSE:PHM) and Toll Brothers (NYSE:TOL).
For more on digging through financial press releases for hidden gems, read The Flow Of Company Information.
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