The Federal Open Market Committee (FOMC) released the minutes of its June 22 and 23 meeting on Wednesday, July 14. The new report – the first to fully reflect the recent events in Europe and more mixed economic data in the United States – contained few surprises. As expected, the Committee downgraded its central tendency projections for domestic economic growth and for the job market.

The Committee also expressed renewed concerns about the need for further monetary policy intervention should the nascent recovery falter in the coming months. Of course, the notion that central bankers "would need to consider whether further policy stimulus might become appropriate if the outlook were to worsen appreciably" is textbook macroeconomics rather than a case of policy innovation.

The FOMC now projects that the economy will grow at a real rate of 3.0 to 3.5 percent in 2010, 3.5 to 4.2 percent in 2011, and 3.5 to 4.5 percent in 2012. The long-run projection is for growth of 2.5 to 2.8 percent. Critically, these GDP projections falls short of forecasts for the federal deficit, reinforcing that a larger share of the economy's output will be deployed in servicing our accumulated debt.

The downward adjustments in the Committee’s projections fall in 2010 and 2011, where growth was projected to be marginally higher when the FOMC met in April. In explaining the revision, the Committee expressed concerns about the impact of weak consumer and business sentiment and restrictive credit:

Many participants anticipated that the economic expansion would be held back by firms’ caution in hiring and spending in light of the considerable uncertainty regarding the economic outlook, by households’ focus on repairing balance sheets weakened by equity and house price declines, and by tight credit conditions for small businesses and households. In all, the FOMC sees risks remaining to the downside.

More than for their GDP estimates, the Committee members ratcheted back their expectations for job growth. The unemployment rate is projected to fall to between 9.2 percent and 9.5 percent in 2010, 8.3 percent and 8.7 percent in 2011, and 7.1 percent and 7.5 percent in 2012. The FOMC projections are generally consistent with private sector forecasts; the Wall Street Journal's most recent survey of economists shows an average projection of 9.4 percent for year-end 2010 unemployment and 8.6 percent for year-end 2011. Based on these near-term estimates, a return to pre-recession employment is likely four or five years off.  Inflation is projected to remain well-within the Fed’s target range over this period while deflation is still deemed an outside risk.

Commercial Real Estate Singled Out

The Committee cited specific concerns about the health of commercial real estate markets, writing as follows:

The outlook in commercial real estate markets stayed weak; prices of commercial properties fell a bit further in the first quarter, and the volume of commercial property sales remained light. The delinquency rate for securitized commercial mortgages continued to climb in May, and indexes of prices of credit default swaps on commercial mortgages declined, on net, over the intermeeting period.

On a more positive note, the Committee cited anecdotal evidence of an improvement in credit availability for good credit quality borrowers:

Participants also noted ongoing difficulties in financing commercial real estate. Nonetheless, reports suggested that more-creditworthy business borrowers were still able to obtain funding in the open markets on fairly attractive terms, and a couple of participants noted that credit from the banking sector, which had been contracting for some time, was showing some tentative signs of stabilizing.

Overall, the deterioration in legacy lending portfolios remains a factor for the stability of banking:

… despite improvements in the condition of banking institutions, strains in the commercial real estate sector were seen as posing risks to the balance sheets of such institutions for some time … Participants noted that problems in the commercial real estate market and the effects of financial regulatory reform could lead to greater constraints on credit availability, thereby restraining growth of output and employment.

Some Implications for the Sector

Based on the Committee’s underlying assumptions of weak employment growth over a protracted period, sustainable improvements in fundamentals will occur later than traditional business cycle models suggest. In the Committee's assessment, the magnitude of the sector’s challenges has broader economic and financial market implications.

Offsetting weak demand for space as a result of lackluster employment growth, acquisition, development, and construction (ADC) credit terms will remain restrictive, limiting medium-term supply growth.

Absent inflationary pressures, risk-free interest rates will remain low for the foreseeable future, mitigating the negative impact of wider risk spreads on property values and loan pricing.