A thorough read of the minutes of the April 30 / May1st meeting of the Federal Open Market Committee (FOMC) shows a Committee not in any mood to risk an early or premature end to the asset purchase program. Markets have focussed on Ben Bernanke’s comments during his Congressional testimony that suggested the FOMC could potentially reduce the quantum of asset purchases “in the next few meetings”. The important qualification was that this would only happen if the outlook for the economy continues to improve along with the level of confidence in the sustainability of that improvement.
The assessment of the current state of, and
outlook for, the economy in the Minutes bore no surprises. The meeting participants recognised the costs
of fiscal drag in constraining aggregate demand, the improvement in the housing
market (though off a low base) and that progress was being made in the labour market. However, the Committee also noted that the recent
decline in the unemployment rate is overestimating the reduction in slack in
the labour market given the decline in the participation rate.
I have made the point before that it is
unlikely a reduction in the unemployment rate that has been in large part due
to people opting out of the labour market meets the FOMCs conditions for a substantial
improvement in labour market conditions.
While there are structural reasons why the participation rate should be
trending lower, I think at least some part of the recent decline is
cyclical. If that were to be reversed
continued modest jobs growth could be accompanied by a stabilisation or even
increase in the unemployment rate. Time
will tell. The Committee also noted the
recent soft inflation readings. Core Personal
Consumption Expenditure (PCE) was 1.1% in the year to March.
Much has been made in the media that “one
participant” preferred to begin decreasing the rate of asset purchases
immediately, but has missed the point that “another participant” wanted to add
more stimulus at that meeting. The
important point is: “Most participants emphasized that it was important for the
Committee to be prepared to adjust the pace of its purchases up or down as
needed to align the degree of policy accommodation with changes in the outlook
for the labor market and inflation as well as the extent of progress toward the
Committee’s economic objectives.” While
that was in response to the weaker data at that point, especially the initial read
of March payrolls data, it also seems to me the Committee didn’t want markets
to get too far ahead of themselves in anticipating an end to the asset purchase
My read of the minutes, Bernanke’s
testimony to Congress and other recent speeches from FOMC members (Bullard,
Dudley) is that the Committee is not going to be in any rush to do anything
other than continuing to ease. In his
testimony Bernanke made the important point that a premature tightening of
monetary policy could lead interest rates to rise temporarily but could also
carry a substantial risk of slowing or ending the economic recovery and causing
inflation to fall further.
Given our outlook for the economy we
believe the next move in US monetary policy is a tapering in the pace of asset
purchases. However, they will need to be
conscious of not starting to taper too early.
As soon as they start the process markets will anticipate the eventual
cessation of the program and eventual tightening, even though the Fed will
still be easing at that point. We
continue to expect the earliest we will see a reduction in the pace of asset
purchase will be the end of this year, although recent inflation data is probably
more indicative of a 2014 start to that process. The good news is that when the tapering
begins, it will be because the FOMC sees a fundamental improvement in the outlook
for the US economy.