By Michael S. Derby
Economists believe the Federal Reserve will acknowledge the economic impact of the Japan disaster indirectly, if it does so at all, at Tuesday’s monetary-policy meeting.
Fed watchers reckon that if the central bank wishes to note the fast-moving events in Japan in the wake of a devastating earthquake and tsunami, it will do so under the flag of “geopolitical” uncertainties. Using that phrase will allow central bankers to pay heed to Japan’s situation, as well as the unrest unsettling the Middle East, without committing the Fed to any policy action.
The Fed is unlikely to go any further in the document announcing the outcome of the Federal Open Market Committee meeting because it doesn’t know how these twin currents will play out. Both could be big negatives for the U.S., but it is hard to say right now. Hence the Fed’s likely limited commentary, which should arrive in a policy statement likely to reaffirm the Fed’s commitment to providing support to the economy.
“At this stage, I would be surprised if there was an explicit line in the statement” about Japan, but “there is quite a lot that’s happened in the world,” and the Fed may note that, however vaguely, said Paul Ashworth, economist with Capital Economics.
Economists reckon the policy statement will largely look like the one from late January, albeit with central bankers offering a modest upgrade of their outlook for hiring. That said, an improving outlook at a time where overseas forces could be problematic argues for the Fed being extra careful in how much optimism it shows. “Given all the uncertainties right now, they don’t want to shock the market with anything,” said Julia Coronado, economist with BNP Paribas.
That said, the Fed could play it a different way, if the past offers any precedent.
At the Sept. 20, 2005, FOMC meeting, central bankers were unusually explicit in taking stock of the then-unsettled developments arising from Hurricane Katrina. The Fed said then “the widespread devastation in the Gulf region, the associated dislocation of economic activity, and the boost to energy prices imply that spending, production, and employment will be set back in the near term,” even as it said any economic setbacks were unlikely to generate a more “persistent” threat. The FOMC continued noting hurricane-related factors through the rest of 2005, but ceased doing so by the start of 2006.
The FOMC trotted out its generic “geopolitical” warnings in meetings ahead of the launch of the Iraq invasion in 2003. The meeting in January of that year said “geopolitical risks have reportedly fostered continued restraint on spending and hiring by businesses.” By the May 2003 meeting, it flagged “the ebbing of geopolitical tensions.”
The hurricane-related woes of 2005 and the onset of war in 2003 have, of course, only loose connections to what is happening now. But they do provide some guidance on how Fed policy makers could address the current landscape while at the same time trying to make clear their longer-run view on the economy.
For most economists, the bigger issue is how the Fed phrases its view on hiring and inflation.
“We will watch to see if the characterization of inflation expectations as ‘stable’ is moderately downgraded,” said Deutsche Bank economists.
Of course, if the Fed were to signal inflation expectations were on the rise, the root cause of that shift would be the big jump in food, energy and raw-material costs, some of which is caused by the Middle Eastern troubles falling under the geopolitical-risks category the Fed may choose to note.
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