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US FOMC: Rise of the Aggressive Doves• Disappointing H1 economic performance,downward revisions to GDP over the past threeyears, and rising financial market volatility ledthe Fed to downgrade its outlook not just in thenear term, but also over a longer horizon.Chart 1: Retail Mortgage Spread a Worry to Fed• November FOMC meeting is the first timesince June that economic forecasts will bepublished.• Financial markets have been pleasantlysurprised over the past month by incoming dataconsistent with the 2.5% q/q saar reading on Q3GDP growth. However, the performance hasbeen less of a surprise to the FOMC whosemembers generally anticipated a strongergrowth performance in H2 2011 as some of thetemporary factors restraining growth eased.Source: Reuters EcoWin ProChart 2: Financial market volatility can take a tollon hiring• Most FOMC participants indicated they sawadvantages in being more transparent about theconditionality in the Committee’s forwardguidance by providing more information aboutthe economic conditions to which the guidancerefers. The November meeting with its forecastand post-meeting press conference is ideallysuited to roll out such a new policy framework.• While it may have appeared in recent monthsthat the Fed was becoming less aggressive, itnow appears that they were simply steppingback and reformulating their reaction function.A weaker outlook for longerSomething momentous happened at the Fed inAugust. A disappointing H1 economic performance,downward revisions to GDP over the past threeyears, and rising financial market volatility led theFed to downgrade its outlook not just in the nearterm, but also over a longer horizon. In June, theFOMC statement said, “the slower pace of therecovery reflects in part factors that are likely to betemporary”. However, the statement released afterthe August meeting acknowledged that “temporaryfactors…appear to account for only some of therecent weakness in economic activity”.Much of the Fedspeak in recent months has cited thefiscal adjustment taking place at the state and locallevel and likely to take place in coming years at thefederal level, and refocused attention on the specialrole the ongoing housing correction plays inrestraining the recovery.Source: Reuters EcoWin ProChart 3: Aggressive policy has helped avert worseeconomic outcomesSource: Reuters EcoWin ProThus began a recalibration of the Fed’s reactionfunction. A lower growth outlook means lessprogress on their mandates. Policies in place may,therefore, not be strong enough to produce desiredresults as they were based on a forecast for animmediate return to self-sustaining above-trendgrowth. In addition, emerging downside risks to theoutlook suggested a more aggressive stance.Julia Coronado 27 October 2011Market Mover4www.GlobalMarkets.bnpparibas.com