The Federal Open Market Committee (FOMC) convened on October 28, 2003, to discuss the prevailing economic conditions and formulate appropriate monetary policy. Presentation materials from this meeting shed light on the key economic indicators and financial market trends that shaped the committee’s deliberations. A significant focus was placed on the Euro-Dollar exchange rate and its implications within the broader context of domestic and international financial landscapes. This article analyzes these presentation materials, highlighting the discussions around interest rates, exchange rate dynamics, and the overall economic outlook that informed the FOMC’s policy decisions on this pivotal date.
The meeting materials, presented by Mr. Kos and Mr. Reinhart, provide a detailed snapshot of the financial environment leading up to October 28, 2003. Mr. Kos’s presentation focused on the then-current state of various financial markets, including deposit rates, treasury yields, corporate debt spreads, and exchange rate volatility. Mr. Reinhart’s materials delved into monetary policy alternatives, assessing the arguments for maintaining or adjusting the target federal funds rate.
Financial Market Overview: Insights from Mr. Kos
Mr. Kos’s presentation commenced with an examination of short-term deposit rates in the U.S. and Euro area. Data from August 1st to October 24th, 2003, indicated an upward trend in both U.S. and Euro area forward rate agreements, particularly following the September employment report. This suggested a growing expectation of future interest rate increases in both regions.
The presentation further highlighted the movements in U.S. Treasury yields. Both 2-year and 10-year Treasury yields experienced increases after the September employment report, mirroring the trend observed in forward rate agreements. This rise in yields reflected market adjustments to evolving economic data and expectations regarding future monetary policy.
Corporate debt spreads also came under scrutiny. The investment-grade corporate option-adjusted spread in the U.S. had narrowed since the previous FOMC meeting in September. Similarly, the high-yield corporate option-adjusted spread exhibited a narrowing trend. These tighter spreads indicated improved credit market conditions and potentially reduced risk premiums demanded by investors.
Volatility in equity and foreign exchange markets was another area of focus. The VIX index, a measure of implied volatility in equity markets, had declined, suggesting a decrease in investor uncertainty in the stock market. Furthermore, one-month option implied volatility for both the Euro-Dollar and Dollar-Yen exchange rates had decreased since the September G-7 communiqué. This decline in implied volatility across currency pairs indicated a period of relative stability in the foreign exchange market, at least in terms of expected short-term fluctuations.
Euro-Dollar Exchange Rate Dynamics
A significant portion of Mr. Kos’s presentation was dedicated to the Euro-Dollar exchange rate. Data from August to October 2003 revealed a depreciation of the U.S. dollar against the Euro. This trend was visually represented, underscoring the strengthening of the Euro relative to the dollar during this period. The presentation also noted the dollar’s depreciation against other Asian currencies, including the Japanese Yen, Thai Baht, and Hong Kong dollar.
The appreciation of the Yen against the U.S. dollar was specifically highlighted. Separate charts illustrated both the Euro-Dollar and Dollar-Yen exchange rate movements, reinforcing the weakening dollar trend across major currency pairs.
Japanese Intervention in the Dollar-Yen Market
Mr. Kos’s materials also included data on Japanese intervention in the Dollar-Yen exchange market. The data revealed a sharp increase in net yearly intervention volume in Dollar-Yen during 2003, as well as a rise in the frequency of interventions. However, it was noted that most of these interventions were in amounts less than 4 billion U.S. dollars. Analysis of intraday spreads for intervention and non-intervention days suggested a decline in the average intraday spread, possibly indicating a change in market response to intervention activities over time.
Monetary Policy Alternatives: Mr. Reinhart’s Briefing
Mr. Reinhart’s presentation shifted the focus to monetary policy alternatives, providing materials for a briefing on potential policy paths. His exhibits analyzed financial market conditions, presented the case for maintaining an unchanged target federal funds rate, and explored the case for easing by 25 basis points.
Exhibit 1 in Mr. Reinhart’s materials provided an overview of financial market conditions. Expected federal funds rates, derived from futures quotes, showed a slight upward revision over the intermeeting period. Futures markets suggested an expected federal funds rate of around 3 percent by the first quarter of 2006.
Primary dealers’ expectations, surveyed by the FRBNY, indicated a balanced outlook on growth but a downside risk to price stability. Policy uncertainty, measured by option-implied measures, had increased, possibly signaling investor anticipation of a potential shift in policy outlook. The implied distribution of the federal funds rate about six months ahead had shifted to the right, indicating increased probability attached to higher funds rates. Despite these shifts, broader financial conditions were assessed as having eased slightly since the September FOMC meeting. Corporate bond yields had edged lower, the Wilshire 5000 index had moved higher, and the Nominal Trade-Weighted Major Currency Index continued its decline.
Arguments for an Unchanged Federal Funds Rate
Exhibit 2 outlined the arguments for maintaining an unchanged target federal funds rate. The key points included:
- Eased financial market conditions.
- Accommodative existing policy.
- Potential emergence of resource pressures.
The actual real federal funds rate was already below the estimated equilibrium real rates, suggesting that further easing could significantly increase monetary policy accommodation. The October Greenbook projection for real GDP was notably higher than the September projection, hinting at potential future resource pressures. Inflation compensation measures had also risen, possibly indicating a pickup in inflation pressures, although special factors might have contributed to this increase.
Arguments for Easing by 25 Basis Points
Exhibit 3 presented the case for easing by 25 basis points. The arguments included:
- Lingering resource slack in the economic outlook.
- Uncertainty regarding the durability of the economic expansion.
- Lack of revival in financial flows.
Unemployment rate projections in alternative scenarios (“faltering economic recovery” and “adverse market reaction”) showed persistently elevated unemployment, contrasting with the baseline projection of declining unemployment. Inflation projections in these alternative scenarios indicated a more pronounced downward movement in core PCE inflation compared to the baseline scenario. M2 money growth had slowed sharply, and net debt financing of nonfinancial businesses remained weak, further supporting the case for easing to stimulate economic activity.
Discussion on FOMC Statement Language
Exhibit 4 addressed issues related to the FOMC statement, particularly the language concerning the balance of risks. It presented possible configurations of risks to economic growth and inflation, categorizing scenarios as “inflation undesirably low,” “balanced,” and “upside risks to sustainable growth.” The existing FOMC statement language was deemed consistent with the “inflation undesirably low” configuration, while a potential near-term transition to a “balanced” or “inflation undesirably low -or- balanced” configuration was considered.
The exhibit also discussed the sentence, “…the Committee believes that policy accommodation can be maintained for a considerable period.” Dropping this sentence was considered potentially risky, possibly leading to an outsized market reaction and expectations of a more aggressive policy tightening. Alternative phrasing, such as “…the Committee believes that policy accommodation can be maintained for the considerable period it currently assesses will be required to foster the moderation of disinflationary pressures,” was also considered.
Conclusion
The presentation materials from the October 28, 2003 FOMC meeting offer a valuable glimpse into the economic and financial considerations that shaped monetary policy decisions at that time. The discussions surrounding the Euro-Dollar exchange rate, alongside analyses of interest rates, inflation indicators, and economic growth projections, underscore the complexity of the factors influencing policy deliberations. The materials reveal a committee grappling with balancing the risks of prolonged disinflation against the potential for future inflation pressures and considering the appropriate level of policy accommodation in a dynamic global economic environment. The focus on the “28 Euro Dollar” exchange rate within these discussions highlights the interconnectedness of global finance and its relevance to U.S. monetary policy considerations.
