Thursday, June 20, 2013

The Fed

Today’s FOMC statement did not deliver the expected dovish tones.  Speculation has risen in markets recently that the Fed would soon begin reducing the pace of asset purchases.  The FOMC did nothing today to dispel that expectation, in fact Chairman Bernanke’s post meeting remarks said that policymakers expect to begin tapering asset purchases “later this year” and continue “in measured steps through the first half of next year, ending around mid-year.  Our own view has been the Fed will begin tapering late this year at the earliest. 

It’s important to note the policy outlook is heavily contingent on economic conditions playing out as expected.  Importantly, the Committee sees that downside risks to the outlook for the economy and the labour markets having diminished since the US autumn (when QE3 began).  Bernanke also stated the policy outlook was based on the unemployment rate moving down to 7% by the middle of next year. 

Latest Fed forecasts have scaled back their GDP forecasts for this year, but they still imply stronger growth in the second half of this year than we have seen in the first half.  Growth forecast for next year were nudged slightly higher.  Inflation forecast were lowered for this year (from the Statement: “partly reflecting transitory influences”), but they note that longer-term inflation expectations have remained stable.  Inflation is expected to rise next year.  While much attention is being paid to the GDP and unemployment rate forecasts, remember it’s the FOMC’s inflation expectations that will ultimately determine the path for monetary policy.

It’s also important to remember that a timetable for reducing quantitative easing is not as hawkish as a tightening in policy.  Interest rate increases are still a long way off with the majority of FOMC participants not expecting a rate hike until 2015.

Today’s Statement moves our expectations of the start of the Fed tapering more firmly into later this year.  But as with the Fed themselves, that is contingent on the expected pick-up in GDP growth, continued declines in the unemployment rate (through more jobs, not lower participation), and increased confidence that inflation will start to head towards 2% over time.   In that sense, the beginning of the Fed reducing its asset purchase program is good news.