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Meeting of the Federal Open Market Committee
March 20-21, 2007 Presentation Materials -- Text Version

Presentation Materials (PDF)

Pages 180 to 196 of the Transcript

Appendix 1: Materials used by Mr. Dudley

Class II FOMC -- Restricted FR

Page 1

Top panel
(1)

Title: 60+ Days Delinquency Rates for Mortgages: FRM versus ARM
Series: Prime adjustable rate mortgages, prime fixed rate mortgages, subprime adjustable rate mortgages, and subprime fixed rate mortgages
Horizon: March 2004 - December 2006
Description: Delinquency rates for subprime adjustable rate mortgages have increased more quickly than subprime fixed rate mortgages in the second half of 2006.

Source: Mortgage Bankers Association

Middle panel
(2)

Title: 60+ Days Delinquencies by Vintage (Subprime ARMs)
Series: Level of 60+ day delinquencies on subprime mortgages backing MBS pools. Shows delinquency levels according to year in which subprime MBS was issued.
Horizon: 2001 to 2006
Description: Delinquency rates for mortgages originated during 2006 are increasing much faster than those of recent years.

Source: Intex

Bottom panel
(3)

Title: Spread Widening in the ABX* Migrated Up the Capital Structure
Series: BBB, BBB-, AAA, AA, A
Horizon: November 13, 2006 - March 16, 2007
Description: The deterioration in the quality of subprime mortgage credit has led to a sharp widening in credit spreads for the ABX indices.

* ABX Series 06-02  Return to text

Source: UBS

Page 2

Top panel
(4)

Title: Spread Widening in ABX, then CDS, and Finally Cash
Series: ABS CDS BBB-, ABX 06-2 BBB-, and Cash ABS BBB-
Horizon: September 1, 2006 - March 9, 2007
Description: The spread widening in the ABX index was more pronounced than in either the underlying collateralized debt obligations or the asset-backed securities.

Source: Merrill Lynch

Middle panel
(5)

Title: Subprime Originators in 2006 by Volume
Series: Wells Fargo, HSBC, New Century*, Countrywide, Citigroup, WMC (GE), Fremont*, Ameriquest*, Option One (H&R Block)*, First Franklin (Merrill Lynch), Top 11-20 Originators, and remaining originators
Horizon: 2006
Description: Several of the large monoline originators have either discontinued subprime lending, are distressed, or up for sale.

* Firms highlighted in red have discontinued subprime lending, are distressed, or up for sale.  Return to text

Source: Inside Mortgage Finance

Bottom panel
(6)

Title: Evolution of Equity Growth Estimates for 2007
Series: S&P 500 Top-Down and Bottom-Up Growth Estimates
Horizon: January 1, 2007 - March 2, 2007
Description: Bottom-up S&P equity growth estimates have been converging downward towards the top-down growth estimates which have not changed significantly.

Source: Thompson Financial

Page 3

Top panel
(7) Comparison of Weekly Increases in VIX Index

Source: Bloomberg and Merrill Lynch

Middle panel
(8)

Title: Global Currency Movements Against the Japanese Yen
Series: AUD, NZD, EUR, GBP, and USD
Horizon: February 19, 2007 - March 16, 2007
Description: These higher yielding currencies appreciated the most during the week leading up to the February 27 sell-off, depreciated the most during the week of February 27, and have recovered the most against the yen over the past two weeks.

Source: Bloomberg

Bottom panel
(9)

Title: Net Long IMM Non-Commercial Speculative Positions Relative to Open Interest
Series: YEN, USD, EUR, GBP, AUD, NZD
Horizon: February 20, 2007 - March 6, 2007
Description: The net short positions as a percentage of the overall open interest in the Japanese yen have dropped since February 27, 2007. Net long positions in the British Pound and Australian dollar have also dropped since February 27, 2007.

Source: Bloomberg

Page 4

Top panel
(10) Correlation of Daily Price/Yield Changes

Source: Bloomberg

Middle panel
(11) Correlation of Daily Price/Yield Changes

Source: Bloomberg

Bottom panel
(12)

Title: 2007 Fed Funds Future Curves
Series: Fed funds future curve as of 10/25/2006, 12/12/2006, 1/31/2007, and 03/16/2007
Horizon: October 25, 2006 - March 16, 2007
Description: Since the January 31 FOMC meeting, near-term policy rate expectations have shifted with market participants now expecting a modest reduction in the federal funds rate target by August 2007.

Source: Bloomberg

Page 5

Top panel
(13)

Title: Eurodollar June 2008 - 2007 Calendar Spread
Series: Eurodollar June 2008 - 2007 calendar spread
Horizon: May 1, 2006 - March 16, 2007
Description: Longer term policy rate expectations have shifted sharply since the January 31 FOMC meeting as the market is pricing in a larger move towards easing.

Source: Bloomberg

Middle panel
(14)

Title: Distribution of Expected Policy Target Among Primary Dealers Prior to January 31 FOMC Meeting
Series: Dealer expectations for policy target rate by quarter, average forecast for policy target by quarter, and market rate for policy expectation by quarter as of 1/22/2007
Horizon: Q2 2007 - Q3 2008
Description: There is more dispersion in regards to where dealers expect the policy rate to be in Q1, Q2, and Q3 2008.

Source: Dealer Policy Survey

Bottom panel
(15)

Title: Distribution of Expected Policy Target Among Primary Dealers Prior to March 21 FOMC Meeting
Series: Dealer expectations for policy target rate by quarter, average forecast for policy target by quarter, and market rate for policy expectation by quarter as of 3/13/2007
Horizon: Q2 2007 - Q4 2008
Description: As compared to the January 2007 policy survey, there is less dispersion around where dealers expect policy rates to be in Q2, Q3, and Q4 2008.

Source: Dealer Policy Survey

Appendix 2: Materials used by Mr. Reinhart

Table 1:
Alternative Language for the March 2007 FOMC Announcement

Appendix 3: Materials used by Mr. Reinhart

Material for FOMC Briefing on Monetary Policy Alternatives
Vincent R. Reinhart
March 20, 2007

Class I FOMC - Restricted Controlled (FR)

Exhibit 1
Financial Developments

Exhibit 1 includes charts that provide information on policy expectations and interest rate developments over the intermeeting period. Financial markets encountered some notable turbulence over the intermeeting period and investors seemed to become somewhat less optimistic about the economic outlook.

Top panels

Three charts focusing on policy expectations and uncertainty about the path of policy.

Top-left panel
Expected Federal Funds Rate

A line chart displays the expected path of policy at the January meeting and as of the most recent date. Developments over the intermeeting period did not cause investors to revise their policy expectations in the very near term. However, at longer horizons, the expected path of policy shifted down by about 50 basis points over the period.

Note. Estimates from federal funds and Eurodollar futures, with an allowance for term premia and other adjustments.

Top-center panel
Six-Month Eurodollar Implied Volatility

A line chart displays a measure of uncertainty about the path of policy computed from options on Eurodollar futures. This measure moved up sharply over the intermeeting period but remained at relatively low levels by historical standards.

As shown in the chart, a vertical line marks the FOMC meeting on January 31, 2007.

* Width of a 90 percent confidence interval computed from the term structures for the expected federal funds rate and implied volatility.

Top-right panel
Implied Distribution of Federal Funds Rate (Six Months Ahead)*

A bar chart displays the probability density function over realizations of short-term interest rates about six months from now based on options prices. The center of mass of this distribution shifted toward lower rates over the intermeeting period and also became noticeably more skewed toward lower rates. The skew toward lower rates might be consistent with anecdotal reports suggesting that investors seemed to be placing higher weight on the possibility of adverse outcomes for the U.S. economy in coming quarters.

* Derived from options on Eurodollar futures contracts, with term premium and other adjustments.  Return to text

Middle-left panel
Subprime Mortgage CDS Index Spreads*

The housing market is one sector that might be a particular cause for concern. A line chart displays an index of credit default swaps on pools of subprime mortgages originated over the first half of 2006. The chart shows a spike in the spreads on lower-rated tranches for this index in recent months as delinquency rates on variable-rate subprime mortgages have soared.

As shown in the chart, a vertical line marks the FOMC meeting on January 31, 2007.

* Translated from price quotes based on JP Morgan's prepayment model.  Return to text

Source: JP Morgan

Bottom-left panel
S&P 500 Index

A line chart displays a time-series of the S&P 500 stock index, which dropped about 1 to 2 percent over the period, evidently reflecting investors concerns about the economic outlook.

As shown in the chart, a vertical line marks the FOMC meeting on January 31, 2007.

Bottom-right panel
Ten-Year Yields

A line chart occupying the bottom-right two thirds of the page displays information on ten-year BBB corporate yields, Treasury yields, and inflation-indexed yields. Nominal and inflation-indexed yields dropped significantly over the period, but nominal yields fell by a bit more implying a modest decline in inflation compensation. Despite concerns about the economic outlook, risk spreads on BBB corporate bonds widened only a little, and the level of BBB corporate yields dropped over the period.

As shown in the chart, a vertical line marks the FOMC meeting on January 31, 2007.

Exhibit 2
Out of the Past

The second exhibit includes a number of charts that compare the current policy environment with that prevailing in 2000.

Top panel
Two-year Treasury spread over the target federal funds rate

A line chart shows a long time-series of the spread between the two-year Treasury yield and the target federal funds rate. This spread has turned negative in recent months as investors have priced in significant odds of policy easing over the next year. This pattern of interest rates was also present toward the end of 2000 as investors observed the weakening of economic activity and concluded that the Federal Reserve would soon move to cut short-term interest rates.

Middle-left panel
Actual and expected federal funds rates in 2000

A line chart displays the path of the target funds rate over 2000 and also shows the expected path of the funds rate at each FOMC meeting that year. Early in the year, market participants anticipated policy tightening given the strength of aggregate demand and some apparent price pressures. Over the course of the year, however, investors began to anticipate easing as the sharp decline in equity markets seemed to foreshadow some weakening in spending.

Middle-right panel
Blue Chip Consensus Forecasts

A line chart displays the evolution over the course of 2000 in the Blue Chip consensus forecast of GDP growth for 2001 and for the average unemployment rate in 2001. Toward the end of 2000, forecasters began to mark down their forecasts for GDP growth in 2001 and revised up their expectations for the average unemployment rate in 2001.

Bottom-left panel
FOMC policy bias in 2000

A bar chart displays information on the Committee's policy bias over this period. The FOMC indicated that it viewed the balance of risks as tilted toward inflation pressures at the first seven meetings of 2000. In the last meeting of the year, the FOMC changed its risk assessment to indicate that risks were weighted toward economic weakness.

Bottom-right panel
Lessons learned

• Statement language can hamper your flexibility.
• Market prices can be informative.
• Forward-looking financial markets help to offset the effects of policy gradualism.

Exhibit 3
Case for Alternative B

Exhibit 3 presents a series of line charts that support the case for alternative B in the Bluebook--leaving the target rate unchanged at 5¼ percent.

Top panels

The top three panels display charts on home sales, the Michigan survey of homebuyer attitudes, and mortgage rates. The state of the housing sector is particularly uncertain with various indicators providing conflicting signals. On balance, the conflicting signals in the housing market may suggest that the Committee might wish to keep the funds rate on hold for a time while it awaits a clearer reading on the direction of the housing market.

Top-left panel
Home sales

As noted in the chart, new and existing home sales have fallen off quite sharply from their peaks in 2005. Existing home sales seem to have stabilized a bit of late, but new home sales still seem to be on a downward track.

Top-center panel
Michigan Survey of Homebuyer attitudes

As shown in the chart, the Michigan survey of homebuyer attitudes suggests that more people regard now as a good time to buy than was true over much of 2006. Still, this series is appreciably below the levels prevailing over much of 2004 and 2005.

Note: Data represent percent answering 'good time to buy' in the Michigan Survey question on buying conditions for houses.

Top-right panel
Mortgage rates

The chart shows one reason why some homebuyers may be feeling more confident. Although rates on adjustable rate mortgages have risen lately, rates on fixed-rate mortgages have remained at the low end of the range observed over the last ten years.

Middle panel
Equilibrium real federal funds rate: Short-run estimates with confidence intervals

As noted in the chart, the Committee might be comfortable with this wait and see policy given that the current setting of the real federal funds rate is in the range of many estimates of the equilibrium real rate--that is, the rate that would close the output gap over time.

Note: Explanatory notes are provided in appendix A of the Bluebook.

Bottom panels

The bottom two panels display optimal policy simulations using the FRB/US that also would support holding the funds rate at 5¼ percent in the near term.

Bottom-left panel
Optimal control: Federal funds rate

As shown in the chart, the funds rate paths from optimal policy simulations in which the policymakers have a 2 percent inflation objective or alternatively in which they have a 1½ percent inflation objective that investors immediately recognize are both fairly flat over the next few quarters.

Bottom-right panel
Optimal control: Core PCE

The chart shows core PCE paths from optimal policy simulations in which the policymakers have a 2 percent inflation objective or alternatively in which they have a 1½ percent inflation objective that investors immediately recognize. The curves dip, then flatten out as they approach their respective inflation objectives over the next six years.

Exhibit 4

The top and middle panels of Exhibit 4 present information on the degree to which policy announcements catch markets by surprise.

Top panel
Estimated Effects of FOMC Policy Statements on Next Month's Federal Funds Futures Contract

A bar chart plots the change in policy expectations at each FOMC meeting since the beginning of 2001. In general, the market reactions to most policy announcements have been rather muted. However, the revisions in policy expectations following a few of the policy easings in 2001 and 2002 were quite notable. The chart suggests that policy tightenings have been fairly predictable in recent years while easings have sometimes been a surprise to market participants.

Note. Change in the yield of the next month's federal funds futures contract from 15 minutes before to 1 hour after the release of an FOMC statement (Change shown for the May 3, 2005 statement is from 15 minutes before to 1 hour after the release of the revised statement).

Middle-left panel
January 2007 Bank of England Policy Decision

Middle-right-top panel
Ten-Year Gilt

A line chart shows that over the next month, ten-year Gilt yields retraced their initial upward movement.

Middle-right-bottom panel
Implied Volatility

A line chart shows that over the next month, measures of interest rate uncertainty edged lower.

Note. Implied volatility of Eurocurrency Pound December 2007 contract multiplied by rate.

All told, this might be taken as evidence that a substantial policy surprise need not be viewed as something that would prompt a large and persistent effect on overall global financial markets.

Bottom panels
The Case for Alternative A

The bottom two panels present information that might support alternative A in the Bluebook--easing policy by 25 basis points at this meeting. The FOMC might prefer this alternative if, in addition to the weakness in the housing sector, the Committee was also concerned about the prospects for business spending.

Bottom-left panel
ISM Business Conditions

As shown in a line chart, recent surveys suggest that businesses have become less optimistic about continued expansion in the manufacturing sector.

Bottom-right panel
ISM Customer Inventories: Manufacturing

As noted in a line chart, many businesses apparently view their customers' inventories as too high, pointing to some potential for cutbacks in production by these firms.

Exhibit 5
The Case for Alternative C

Exhibit 5 presents information that might bear on the Committee's debate concerning alternative C--tightening policy by 25 basis points at this meeting.

Top panel
Survey measures of long-term inflation expectations

As noted in a line chart, measures of long-term inflation expectations have remained above levels that many members are comfortable with in the long-run and some of these measures have edged a bit higher over recent months.

Middle-left panel
Unemployment rate

As noted in a line chart, the current level of the unemployment rate at 4½ percent remains below many estimates of the NAIRU.

Middle-right panel
Foreign real GDP Q4/Q4 change

Bottom-left panel
S&P 500 VIX

As noted in a line chart, despite the recent turbulence in financial markets, implied volatilities remain at fairly low levels. In part, this may be because investors believe that the FOMC will take action to support stock prices in the event of particularly bad economic outcomes.

Bottom-right panel
Five-minute changes in stock prices and policy expectations since Feb. 27

Indeed, as noted in a scatterplot, bond yields* and S&P 500 stock prices were highly positively correlated over the period since February 27. Alternative C might then be viewed as desirable to reinforce the notion that the Committee conducts policy with an eye toward future economic prospects and not to support any particular level of equity prices.

* Futures rate implied by the fourth Eurodollar contract.  Return to text

Appendix 4: Materials used by Mr. Kohn

Class I FOMC
Restricted Controlled (FR)

Page 1

Top panel
The Specification of the Price-Stability Goal

Bottom panel
A Proposed Trial Run for Producing a Forecast Narrative