The Fed Releases the Minutes from Its March Meeting.

• The Fed staff substantially reduced growth projections for 2008—a contraction is now foreseen in the first half of 2008—and the outlook for 2009 was trimmed.
• Even with recent aggressive policy action, some FOMC members were concerned about a deeper downturn in activity.
• Stresses in financial markets had increased significantly since the end of January.
• The Fed responds dramatically and forcefully to deteriorating conditions in the financial markets, and orchestrates the takeover of Bear Stearns in order to avert a potentially catastrophic bankruptcy.
• Readings on inflation were elevated—but expected flattening of oil and commodity prices and easing pressure on resources would lead to some moderation.
• The FOMC injected massive liquidity into the credit markets and cut the federal funds rate by 75 basis points, to 2.25%
• The presidents of the Federal Reserve Bank of Philadelphia and Dallas dissented from the decision to lower rates, raising concerns about pressure on inflation and inflation expectations.

The Federal Open Market Committee's meeting minutes document the most tumultuous period in the financial markets and Fed policy-making since the aftermath of the September 11 attacks and the 2001 recession. First, the FOMC noted that a broad array of economic indicators had deteriorated in recent months. As a result, Fed staff slashed their growth outlook for 2008 and 2009, with a contraction in activity now expected in the first half of 2008. Effectively, Fed staffers are now forecasting a mild recession in the first half of 2008. In addition, the Fed trimmed its growth outlook for 2009 (updated central tendency forecasts will not be released until July).

At the same time, prospects for inflation had deteriorated, as readings on inflation had generally been elevated, and measures of long-term inflation compensation moved up. A couple of regional bank presidents were concerned that inflation expectations might become unhinged with a further lowering of rates, and this was the primary motivation for their dissent from the decision to lower the federal funds rate by a further 75 basis points.

Finally, conditions in the financial markets deteriorated sharply in February and early March, as both long-term and short-term borrowing spreads across a wide variety of debt instruments moved up sharply. In addition, there were dislocations in the markets for municipal securities as bond insurers came under rating downgrade pressure. Downward pressure on bond prices, including highly rated GSE mortgage debt, led to acute funding problems at a couple of large financial entities.

Although not fully documented in the minutes released on April 8, the FOMC responded forcefully to these acute pressures in the financial markets on a number of fronts including: (a) increasing the "term auction facility" from $60 billion in February to $100 billion in March; (b) introducing a $100-billion program of term repurchase agreements—which was expanded into a $200-billion "term securities lending facility" with a broader range of collateral—for primary U.S. Treasury dealers; (c) on March 16, the Fed orchestrated an orderly takeover of Bear Stearns by JP Morgan and extended a collateralized $30-billion line of credit to JPMorgan in order to execute the merger, and at the same time reduced the discount rate by a quarter of point, to 3.25%, and opened the New York Fed discount window to primary dealers; (d) increased currency-swap agreements with the European Central Bank and Swiss National Bank; and (d) on March 18, the FOMC meets and votes to cut the federal funds rate and the discount rate by 75 basis points.

In the short space of a month, the Fed has dealt a series of master strokes in the markets that will go down in the annals of central bank history. Preliminary indications are that the Fed has succeeded so far in reversing some of the extreme risk aversion and negative market pathology that reached a zenith in early March. Spreads of GSE agency bonds have come down sharply—and this has been reflected in lower retail mortgage rates—and credit default swap rates have also come down sharply. The uncertainty hovering over the liquidity positions of the remaining primary dealers has substantially diminished. However, LIBOR spreads and corporate bond spreads have come down more modestly, probably due to lingering concerns about further write-offs in the banking sector and expected pressure on corporate earnings from a very weak economy. On a positive note, pressure on inflation expectations seems to have eased, with measures of inflation compensation coming down by about 20 basis points since early March.

So far, we would have to say that the FOMC's bold actions in March have had their intended effect. However, signals from the economy continue to come in on the weak side, and we would agree that downside risks to the outlook remain salient, even with the recent capitulation from the Fed staff that a mild recession is very likely in the first half of 2008. As a result, we expect the FOMC will move to lower rates by a further 50 basis points at the upcoming meeting of the FOMC on April 30, thereby taking the federal funds rate down to 1.75%.