In the business sector, real
spending on equipment and software declined in the second
quarter as outlays on transportation equipment dropped
sharply. Spending on computers and software rose at a moderate
rate in the second quarter, while outlays on other equipment
improved a bit last quarter after having declined in the
preceding two quarters. Data through June continued to show a
robust increase in nonresidential construction activity.
However, vacancy rates for commercial properties ticked up in
the first quarter, and the architectural billings index
registered a string of weak readings from February to June.
Real nonfarm inventories excluding motor
vehicles fell sharply in the second quarter. The ratio of
book-value inventories to sales (excluding motor vehicles)
ticked down again in May.
The U.S. international trade deficit
narrowed in May, as a large increase in exports of goods and
services more than offset a moderate increase in imports. Most
major categories of non-oil imports rose in May; imports of
consumer goods increased rapidly. In contrast, the value of
petroleum imports fell back despite higher prices, and imports
of automotive products also fell. The increase in exports was
supported by strong exports of industrial supplies,
particularly petroleum products, and services.
Across the advanced foreign economies,
information received since the last meeting pointed to subdued
growth in the second quarter and increasing inflation
pressures. Weak second-quarter data on industrial production
and sentiment in the euro area as well as on consumer
expenditures and exports in Japan suggested that the
first-quarter strength in output growth was not sustained.
Conditions worsened considerably in the United Kingdom, with a
deepening slump in the housing sector. In all the major
advanced foreign economies, rising food and fuel prices
continued to drive overall inflation to recent highs, but core
measures of inflation generally rose only modestly. Recent
indicators for emerging market economies pointed to some
slowing of growth in the second quarter. Real GDP growth in
China moderated but remained strong. Incoming data suggested
further slowing elsewhere in emerging Asia, and second-quarter
activity appeared to have remained sluggish in Mexico.
Headline inflation rose further in much of the developing
world, largely owing to higher food and energy prices, and
several countries continued to face upward pressure on core
inflation as well.
Headline consumer price inflation in the
United States stepped up in recent months, largely as a result
of sizable increases in food and energy prices. Excluding
these categories, core consumer price inflation was elevated
in June but, on balance, was running this year at about the
same rate as last year. Some survey-based measures of
year-ahead inflation expectations moved up sharply in recent
months; longer-term inflation expectations were little changed
recently but remained above their levels at the end of 2007.
Excluding food and energy, sharp increases in the prices of
products and services at earlier stages of processing
continued to put upward pressures on business costs and
consumer prices. Unit labor costs apparently continued to
increase at a restrained pace during the second quarter,
reflecting only moderate gains in worker compensation and
relatively strong productivity performance, with little sign
of higher overall inflation passing through to higher worker
compensation.
At its June 24-25 meeting, the Federal Open
Market Committee (FOMC) kept its target for the federal funds
rate at 2 percent. The Committee's statement noted that recent
information indicated that overall economic activity continued
to expand, partly because of some firming in household
spending. However, labor markets softened further and
financial markets remained under considerable stress. Tight
credit conditions, the ongoing housing contraction, and the
rise in energy prices were likely to weigh on economic growth
over the next few quarters. The Committee expected inflation
to moderate later this year and next. 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 remained high. The Committee stated that the
substantial easing of monetary policy to date, combined with
ongoing measures to foster market liquidity, should help
promote moderate growth over time. Although downside risks to
growth remained, they appeared to have diminished somewhat,
and the upside risks to inflation and inflation expectations
increased. The Committee indicated that it would continue to
monitor economic and financial developments and would act as
needed to promote sustainable economic growth and price
stability.
The market's expected path of monetary
policy moved down following the announcement of the
Committee's decision at its June meeting to leave the target
federal funds rate unchanged. Although the decision was
largely anticipated, the policy statement was reportedly
viewed by investors as placing more emphasis on the downside
risks to growth than they had anticipated. Subsequently, the
semiannual Monetary Policy Report to the Congress and
the accompanying testimony also led investors to mark down the
expected path for the federal funds rate, as did intensifying
concerns about the health of financial institutions and the
outlook for the housing-related government-sponsored
enterprises (GSEs). Consistent with the revision in policy
expectations, yields on short- and medium-term nominal
Treasury coupon securities fell over the intermeeting period.
Yields on long-term Treasury securities declined less than
those on shorter-term instruments, and the yield curve
steepened. Measures of shorter-horizon inflation compensation
derived from yields on inflation-indexed Treasury securities
dropped over the intermeeting period as energy prices reversed
some of their earlier rise, while measures of longer-term
inflation compensation rose slightly.
Functioning in the interbank funding
markets remained strained over the intermeeting period.
Spreads of the London interbank offered rate, or Libor, over
comparable-maturity overnight index swap rates were unchanged
to slightly higher, and spreads on lower-rated nonfinancial
and asset-backed commercial paper remained well above
historical norms. Depository institutions' use of both
overnight and term primary credit borrowing continued to be
strong during the intermeeting period, peaking in late June
amid quarter-end pressures. However, new extensions of credit
through the Primary Dealer Credit Facility (PDCF) were
negligible during July. On July 30, the Board of Governors and
the FOMC announced enhancements to existing liquidity
facilities, including extension of the PDCF and the Term
Securities Lending Facility through January 30, 2009.
Conditions in the market for Treasury repurchase agreements
were fairly stable, although there was some deterioration of
conditions in the market for agency collateral.
In longer-term credit markets, yields on
both investment- and speculative-grade corporate bonds rose
over the intermeeting period even though comparable-maturity
Treasury yields declined slightly, which resulted in a
widening of already elevated spreads. Corporate bond issuance
slowed further, as did lending by banks to businesses and
households, and issuance of leveraged loans remained very
weak. Broad equity price indexes were volatile and declined
modestly, on net, between the June and August FOMC meetings.
Stock prices of financial firms fell sharply in mid-July but
subsequently recouped most of those losses. Energy sector
stocks significantly underperformed the broad indexes owing to
recent declines in oil prices.
Uncertainties about the financial condition
of Fannie Mae and Freddie Mac added to market worries about
the potential consequences of financial strains for the
broader economy over the intermeeting period. On July 13, the
Treasury Department proposed a plan to support the liquidity
and solvency of the two GSEs, and the Board of Governors of
the Federal Reserve System announced that the Federal Reserve
Bank of New York was authorized to lend to the two
institutions if necessary, reducing somewhat market concerns
about the GSEs. Concerns eased further as Congress passed
legislation, which was subsequently signed by the President,
authorizing the Treasury to provide liquidity and capital to
the GSEs. Over the intermeeting period, spreads of rates on
conforming residential mortgages over those on
comparable-maturity Treasury securities moved higher. Offer
rates on 30-year jumbo mortgages also rose, and credit for
nonconforming mortgages remained difficult to obtain. In the
secondary market, issuance of mortgage-backed securities by
GSEs appeared to have slowed in July from its strong
second-quarter pace, while issuance of securities backed by
nonconforming loans and of commercial mortgage-backed
securities remained nil.
Pressures in the money markets of many
major foreign economies eased slightly over the intermeeting
period. Yields on sovereign debt in the advanced foreign
economies fell, mainly because of declines in inflation
compensation. The trade-weighted index of the dollar against
the currencies of major trading partners rose a bit on net.
M2 expanded at a moderate pace in July,
reversing the deceleration in May and June. The expansion was
broad based, reflecting an acceleration in liquid deposits as
well as renewed inflows to retail money market mutual funds
and small time deposits.
In the forecast prepared
for the meeting, the staff marked down its forecast of real
GDP growth in the second half of 2008 and in 2009. Although
the increase in real GDP in the second quarter was a bit
faster than anticipated at the time of the June meeting, the
labor market continued to weaken significantly, financial
conditions remained unfavorable, consumer and business
confidence was downbeat, and manufacturing activity was
contracting. All told, the staff continued to expect that real
GDP would rise at less than its potential rate through the
first half of next year. Nonetheless, real GDP growth was
anticipated to return to its potential rate in the second half
of 2009 as housing activity leveled out and financial
conditions became less restrictive. Core PCE price inflation
was expected to pick up somewhat in the second half of this
year, mostly as a result of the upward pressures from this
year's run-ups in prices of energy and imports. Core inflation
was then expected to edge down in 2009 as the impetus from
prior increases in the prices of imports, energy, and other
commodities abated and the margin of slack in resource use
widened.
In their discussion of the
economic situation and outlook, many FOMC participants noted
that recent developments suggested that economic activity was
likely to remain damped for several quarters. Although
economic growth in the second quarter had apparently been
boosted by fiscal stimulus, resilience in consumption spending
even before tax rebates were distributed, and robust gains in
exports, recent indicators pointed to a near-term deceleration
in household spending and to softer export demand. Moreover,
increasing concerns about financial institutions had
contributed to a widening of some risk spreads and a further
tightening of credit to households and businesses. Growth in
overall economic activity was generally expected to be weak
during the remainder of 2008 before recovering modestly next
year, and nearly all meeting participants saw continuing
downside risks to growth. Recent readings on inflation had
been high, but growth in unit labor costs had remained subdued
and commodity prices had declined of late. Accordingly, most
participants anticipated that inflation would moderate in
coming quarters. However, participants also expressed
significant concerns about the upside risks to inflation,
particularly the risk that longer-term inflation expectations
could become unmoored.
Many participants referred to the adverse
financial sector developments that had occurred over the
intermeeting period. Heightened investor apprehension about
the viability of Fannie Mae and Freddie Mac had eased
following legislative action, but pressures on these firms
continued. Reflecting these strains, interest rates on
residential mortgages had moved upward, a development that was
seen as potentially exacerbating the contraction in the
housing sector. Commercial banks had reported that terms and
standards had been tightened on nearly all categories of
loans. Declining mortgage asset values increased capital
pressures on lenders exposed to real estate markets. While
some financial institutions had strengthened their balance
sheets with new capital issues, raising new capital had become
increasingly difficult. Moreover, broad equity price indexes
had declined and borrowing costs for nonfinancial firms had
increased, including a recent rise in corporate bond yields
across most risk categories. Many participants believed that
these developments were likely to restrain aggregate demand
and economic growth. Others, however, thought that the extent
of such adverse effects was likely to be limited, noting that
bank lending had continued to grow at a moderate pace and that
consumption and business capital spending had increased in the
second quarter despite the tightening of credit terms.
While consumer spending had been bolstered
temporarily by the effects of the tax rebates, retail sales
had weakened during late spring and auto sales had dropped
sharply in both June and July. The unemployment rate jumped
during the intermeeting period, and participants generally
anticipated that payroll employment would decline further in
coming months. For example, automotive parts suppliers in one
District had reported plans for laying off workers, idling
production, and closing several plants. Lower equity prices
and the ongoing deterioration in house prices had reduced
household wealth significantly, while real incomes had been
diminished by earlier increases in the prices of food and
energy. All of these factors--in conjunction with tightened
access to auto loans, home equity lines of credit, and other
consumer loans--were viewed as pointing towards weak growth in
personal consumption expenditures during the second half of
2008.
The weaker outlook for consumer demand,
along with tighter credit conditions for businesses, was
expected to weigh on business spending going forward.
Moreover, some signs of weakness in the commercial real estate
sector were seen as suggesting a slower pace of investment in
nonresidential structures over coming quarters, although that
deceleration might be gradual due to the lags in the planning
and execution of such projects. However, the elevated level of
energy prices was boosting investment in the oil-producing
industry.
Growth in exports had provided substantial
impetus to overall demand in the second quarter. However, many
participants observed that decelerating activity in some
foreign economies would tend to dampen export gains going
forward. Indeed, recent indications of a slowing global
economy may have contributed to the marked declines in the
prices of oil and some other commodities over the intermeeting
period.
Participants pointed to potential
interactions between financial stresses and the housing market
contraction as the primary source of continuing downside risks
to growth. Many participants noted that the financial system
remained fragile, with some expressing continued concern about
the possibility of an adverse feedback loop in which tighter
conditions in the mortgage market would contribute to further
declines in the housing sector and additional losses for
lenders, leading to further tightening of lending terms and
standards. In contrast, several other participants suggested
that risks to the financial system had receded, partly as a
result of the implementation by the Federal Reserve of special
liquidity facilities, and that prevailing credit conditions
were broadly consistent with the typical patterns observed
during periods of weak growth or recession.
Headline inflation was generally expected
to moderate in coming quarters, reflecting importantly an
anticipated leveling-out of prices for energy and other
commodities. Although measures of core inflation might well
edge up later this year, given the pass-through to final goods
prices of earlier increases in the prices of energy and other
inputs, most participants anticipated that core inflation
would edge back down during 2009. Some participants reported
that firms were increasingly using various pricing
strategies--such as escalation clauses or the imposition of
fuel surcharges--to pass higher costs on to their customers,
who were apparently becoming less resistant to such price
adjustments. However, one participant mentioned the difficult
pricing decisions of manufacturers who face a combination of
elevated input costs along with weakening demand for their
products. And a number of participants noted that the outlook
for slack in resource utilization should tend to limit the
extent of pass-through, contain the degree of inflation
spillover to goods and services without high commodity
content, and reinforce the anticipated moderation in
inflation.
Participants expressed significant concerns
about the upside risks to inflation, especially the risk that
persistently high headline inflation could result in an
unmooring of long-run inflation expectations. Some viewed the
upside risks to inflation as having diminished modestly over
the intermeeting period, mainly as a result of the drop in the
prices of oil and some other commodities as well as the
greater likelihood of persistent economic slack. However,
others viewed these risks as having increased, particularly in
light of continued elevated readings on headline inflation,
the low level of the real federal funds rate, anecdotal
information suggesting that firms were having more success in
passing higher costs on to their customers, and some signs of
an upward drift over recent months in investors' expectations
and uncertainty regarding inflation over the longer run;
moreover, the recent decline in energy prices might well be
reversed in coming months. A number of participants worried
about the possibility that core inflation might fail to
moderate next year unless the stance of monetary policy was
tightened sooner than currently anticipated by financial
markets.
In the Committee's
discussion of monetary policy for the intermeeting period,
members agreed that labor markets had softened further, that
financial markets remained under considerable stress, and that
these factors--in conjunction with still-elevated energy
prices and the ongoing housing contraction--would likely weigh
on economic growth in coming quarters. In addition, members
saw continuing downside risks to this outlook, particularly
reflecting possible further deterioration in financial
conditions. Members generally anticipated that inflation would
moderate; however, they emphasized the risks to the inflation
outlook posed by persistent high readings on headline
inflation and a possible unmooring of inflation expectations.
Against this backdrop, nearly all members judged that leaving
the federal funds rate unchanged at this meeting was
appropriate and would most effectively promote progress toward
the Committee's dual objectives of maximum employment and
price stability. Most members did not see the current stance
of policy as particularly accommodative, given that many
households and businesses were facing elevated borrowing costs
and reduced credit availability due to the effects of
financial market strains as well as macroeconomic risks.
Although members generally anticipated that the next policy
move would likely be a tightening, the timing and extent of
any change in policy stance would depend on evolving economic
and financial developments and the implications for the
outlook for economic growth and inflation.
At the conclusion of the
discussion, the Committee voted to authorize and direct the
Federal Reserve Bank of New York, until it was instructed
otherwise, to execute transactions in the System Account in
accordance with the following domestic policy directive:
"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 the federal funds rate at an average of around 2
percent."
The vote encompassed approval of the
statement below to be released at 2:15 p.m.:
"The Federal Open Market Committee decided
today to keep its target for the federal funds rate at 2
percent.Economic activity expanded in the second quarter,
partly reflecting growth in consumer spending and exports.
However, labor markets have softened further and financial
markets remain under considerable stress. Tight credit
conditions, the ongoing housing contraction, and elevated
energy prices are likely to weigh on economic growth over the
next few quarters. Over time, the substantial easing of
monetary policy, combined with ongoing measures to foster
market liquidity, should help to promote moderate economic
growth. Inflation has been high, spurred by the earlier
increases in the prices of energy and some other commodities,
and some indicators of inflation expectations have been
elevated. The Committee expects inflation to moderate later
this year and next year, but the inflation outlook remains
highly uncertain. Although downside risks to growth remain,
the upside risks to inflation are also of significant concern
to the Committee. The Committee will continue to monitor
economic and financial developments and will act as needed to
promote sustainable economic growth and price stability."
Votes for this action:
Messrs. Bernanke and Geithner, Ms. Duke, Messrs. Kohn,
Kroszner, and Mishkin, Ms. Pianalto, Messrs. Plosser, Stern,
and Warsh.
Votes against this action:
Mr. Fisher.
Mr. Fisher dissented because he favored an
increase in the target federal funds rate to help restrain
inflation and inflation expectations, which were at risk of
drifting higher. While the financial system remained fragile
and economic growth was sluggish and could weaken further, he
saw a greater risk to the economy from upward pressures on
inflation. In his view, businesses had become more inclined to
raise prices to pass on the higher costs of imported goods and
higher energy costs, the latter of which were well above their
levels of late 2007. Accordingly, he supported a policy
tightening at this meeting.
It was agreed that the next meeting of the
Committee would be held on Tuesday, September 16, 2008.
The meeting adjourned at 1:50 p.m.
Conference Call
On July 24, 2008, the Federal Open Market Committee met in a
joint session with the Board of Governors to consider several
proposals to extend or enhance Federal Reserve System
liquidity facilities. In light of continued significant
stresses in financial markets and the experience to date with
the Term Auction Facility (TAF), the Term Securities Lending
Facility (TSLF), and the Primary Dealer Lending Facility (PDCF),
the staff proposed modifications to these programs. The
modifications included auctioning options on up to an
additional $50 billion of TSLF loans and lengthening the term
to maturity of all loans made under the TAF to 84 days.
Contingent upon Board approval of the change to TAF loans, the
Committee was asked to consider an expansion of the existing
currency swap arrangement with the European Central Bank to
facilitate a similar change in the term of dollar credits
auctioned by the ECB. Finally, policymakers were asked to vote
on extending the availability of the TSLF and PDCF past the
year-end, a topic that had been discussed on a preliminary
basis at the joint Board/FOMC meeting on June 25, 2008.
In the discussion, meeting participants
exchanged views on issues entailed in administering the TAF
and term primary discount window credit. Issues regarding
credit risk and collateral requirements received particular
attention.
Some participants raised questions about
the net benefit of approving and announcing the proposed
changes at this time, asking, for example, whether such an
announcement could suggest that the Federal Reserve saw
financial markets as more fragile than expected or whether
adjustments to the liquidity facilities could cause market
analysts to infer that the System intended to keep the
facilities in place permanently. Most participants expressed
general support for the proposals as improving the System's
tools for supporting market liquidity. However, there was
considerable sentiment for altering the TAF proposal to allow
for both 28- and 84-day credits, and the Chairman directed the
staff to confer, to consult further with policymakers, and to
revise the proposal accordingly for notation votes in the near
future by the Board and the FOMC.
At this meeting, the Committee unanimously
approved the following resolution:
TSLF Extension Authorization
The FOMC extends until January 30, 2009, its authorizations
for the Federal Reserve Bank of New York to engage in
transactions with primary dealers through the Term Securities
Lending Facility, subject to the same collateral, interest
rate and other conditions previously established by the
Committee.
With Mr. Plosser dissenting, the Committee
voted to approve the resolution below. Mr. Plosser dissented
because he viewed the net benefit of the TSLF options as being
insufficient to justify adding them to the support already
being provided to market liquidity.
TSLF Options Authorization
In addition to the current authorizations granted to the
Federal Reserve Bank of New York to engage in term securities
lending transactions, the Federal Open Market Committee
authorizes the Federal Reserve Bank of New York to offer
options on up to $50 billion in additional draws on the
Facility, subject to the other terms and conditions previously
established for the Facility.
Mr. Lockhart voted as alternate member at
this meeting.
Notation Votes
By notation vote completed on July 14, 2008, the Committee
unanimously approved the minutes of the FOMC meeting held on
June 24-25, 2008.
By notation vote completed on July 29,
2008, the Committee unanimously approved the following
resolution:
Swap Authorization
The Federal Open Market Committee directs the Federal Reserve
Bank of New York to increase the amount available from the
System Open Market Account under the existing reciprocal
currency arrangement ("swap" arrangement) with the European
Central Bank to an amount not to exceed $55 billion. Within
that aggregate limit, draws of up to $25 billion are hereby
authorized. The swap arrangement continues to be authorized
through January 30, 2009, unless extended by the Federal Open
Market Committee.
The
information reviewed at the August meeting indicated that the
economy expanded at a moderate pace in the second quarter, but
recent financial market developments highlighted some of the
stresses that the economy faced going forward. Both consumer
and business spending recorded gains in the second quarter,
and net exports contributed importantly to the rise in real
gross domestic product (GDP). However, residential
construction continued to fall sharply, the labor market
weakened further, and industrial production declined. Core
consumer price inflation remained relatively stable, while
headline inflation was elevated as a result of large increases
in food and energy prices.