Some quick points from Goldman’s Sven Jari Stehn on today’s FOMC:
- Following Friday’s downward revisions, we now expect real GDP to increase just 2%-2½% (annualized) through the end of 2012 and the unemployment rate to rise slightly to 9¼% during this period. Moreover, we forecast the year-on-year rate of core inflation to fall from a peak of around 2% in late 2011 to 1¼% in late 2012. What are the implications of these forecast changes for the Fed outlook? Our Taylor rule–which describes the funds rate with forecasts of inflation and the unemployment gap–highlights two implications.
- First, some more easing might be needed to fill some of the widened gap between the actual and “warranted” funds rate. We now think that Fed officials will take two small steps in this direction for the remainder of 2011: (1) expand the scope of their “extended period” language to cover not just the exceptionally low funds rate but also the exceptionally large balance sheet (we expect this at Tuesday’s FOMC meeting), and (2) shift the composition of the balance sheet towards longer maturities.
- Second, the downgrade of our outlook reaffirms our longstanding call for no funds rate hikes until 2013, and it could well be even later. Indeed, our Taylor rule suggests that it could be as long as late 2014 before the first funds rate hike becomes appropriate. We also now expect that Fed officials will continue to reinvest maturing/prepaid securities until 2013.