The Federal Open Market Committee decided today to get on with the job of reducing the pace of their asset purchase program. The Committee decided to reduce the program by $10 billion per month to $75 billion per month, cutting both Treasury and MBS purchases by $5 billion each. Markets have responded well, bolstered by changes to the language around their forward guidance which reinforces that interest rates will remain low for a long time.
The Committee noted recent data which
“indicates that economic activity is expending at a moderate pace”. Indeed our read of the data has been that the
labour market data has become more consistently solid and that is showing
through in real economic activity such as household spending. If the Committee hadn’t announced a tapering
decision today, they would have at least had to acknowledge they were very
close to doing so.
Market reaction has reflected that while
the Committee announced a reduction in their asset purchase program, the
overall tone of the statement was on the “dovish” side. Firstly, the Committee said that the future
path of tapering was not on a pre-determined path and would remain data dependant.
So long as the labour market continues to improve and inflation moves back
towards its long run objective “the Committee will likely reduce the pace of
asset purchases in further measured steps at future meetings”.
Secondly, forward guidance was
strengthened, but through their use of language rather than the expected change
to the level of the unemployment rate at which they would consider interest
rate increases. The Committee states
that “it likely will be appropriate to maintain the current target range for
the Fed funds rate well past the time
that the unemployment rate declines below 6.5%, especially if projected
inflation continues to run below the Committee’s 2 percent longer-run goal.” Previously the Committee had signalled to
maintain the current target range for the Fed funds rate at least as long as
the unemployment rate remains above 6.5%.
Importantly, the decision to start tapering
has removed a major distraction for markets.
The key risk around tapering risk was always the initial
announcement. But today demonstrates the
Committee continues to manage its communications exceptionally well. Furthermore, since the decision in September not
to taper, markets have become increasingly comfortable with the idea. That has of course been helped by the recent
strength in the data.
The overriding message today is that while
the US economy still requires the ongoing support of low interest rates for
some time to come, there has been sufficient improvement in the fundamentals to
justify the winding back of asset purchases and that given the outlook,
particularly for inflation, it will be a long time before interest rates need
to rise. That’s all good news.