Monetary Policy: Holding Steady
On May 30, the Federal Reserve Open Market Committee (FOMC) released the minutes from its May 9 meeting. The minutes noted that the economy had expanded “at a below-trend pace in recent months.” The committee commented on weak demand in the housing market, a slowdown in consumer spending, and “subdued” business fixed investment. However, the staff forecasted a pickup in economic activity “to a rate a little below that of the economy’s long-run potential for the remainder of this year.” The committee also expects core inflation to “slow gradually” but recognizes there is “considerable uncertainty” regarding that judgment. Inflation remains the predominant concern in the committee’s view, and “some noted that a failure of inflation to moderate could entail significant costs particularly if it led to an upward drift in inflation expectations.”
The release of the minutes did not have substantial impact on market participants’ views of the future course of monetary policy. Currently, participants place over a 97 percent probability on the committee maintaining the federal funds rate at 5.25 percent at the June meeting. This probability has steadily increased over the past month. Looking further ahead toward the August meeting, participants overwhelmingly expect no change in policy.
Participants in the market for federal funds futures currently expect some possibility of future rate cuts but not until the later part of the year. Eurodollar futures provide a longer-run perspective on the expected course of monetary policy. These, too, indicate expectations of an upcoming round of rate cuts.
In implementing monetary policy, the Trading Desk of the New York Fed conducts open market operations in order to influence the supply of nonborrowed bank reserves. By affecting the supply of reserves, the Desk attempts to maintain the federal funds rate near the target set by the FOMC. Typically, the effective daily rate remains close to the target. In 2006, the average absolute deviation of the effective daily rate from target was only 3 basis points. Furthermore, the funds rate normally displays little intraday variability. For 2006, the average intraday standard deviation of the rate was only 7 basis points.
There are some noticeable patterns in the behavior of the funds rate. Fund rate volatility tends to be greater on high payment flow days—the first and last business days of the month as well as the first business day after the 14th of each month. In fact, the largest intraday range of the federal funds rate during 2006 occurred on June 30, when the high-low spread of the funds rate reached 5 percentage points. The funds rate also tends to trade above the target for several days before anticipated increases in the rate at FOMC meetings.