Thursday, March 20, 2014

No Change in policy direction from the Fed

US Federal Reserve FOMC meetings always garner a bit of attention.  This week’s meeting was more interesting than most, being the first meeting in which Janet Yellen was in the Chair.  But while there were some changes to the Statement, the FOMC’s policy direction is fundamentally unchanged.

The most immediate question for policy (and markets) was how they would judge and respond to recent weakness in the economy.  As most analysts have, the FOMC was happy to attribute the soft data to the weather and conclude the economy remains fundamentally sound.  We agree with that, although we add in the inventory cycle as another reason for the recent weakness and is why we are happy being at the lower end of market expectations for US GDP growth this year.

Given that view the Committee proceeded with a further reduction in their asset purchase program to US$55 billion per month, the third consecutive reduction of US$10 billion per month.  While the Committee again reiterated that reductions in the program are not on a pre-set course, todays move confirms our suspicions that the hurdle for reducing (or indeed increasing) the pace of tapering is set quite high.  The reality is the market volatility that would result from altering the pace of the purchases would be more costly to the real economy than the benefit of the change in quantum of purchases.

While broad policy direction was unchanged, the Committee did change its rate guidance from a quantitative approach to qualitative: the 6.5% unemployment rate threshold for considering rate hikes is now gone.  With the unemployment rate currently at 6.7%, that level is likely to be breached soon.  In its place, the Committee will now “take into account a wide range of information, including measures of labour market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments”.  That’s great and simply indicates further normalisation of the monetary policy process. 

However to reinforce the Committee’s expectations that it will maintain the current target range for the Fed funds rate for a considerable time the Committee felt compelled to stress that the change in guidance did not indicate any change in the Committee’s policy intentions as set forth in its recent statements.

The most interesting aspect of the central tendency forecasts was the higher policy rate forecasts.  The 2015 median rate moved up to 1.00% from 0.75% and the 2016 median was higher at 2.25%, up from 1.75%.  We’re pretty relaxed about that (as Yellen also appeared in her press conference).  Those rates are still well below the Committee’s estimate of the equilibrium rate.

If you doubt the Feds “dovishness” you just need to read this: “….even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run”.  This is not an FOMC that’s going to be in a hurry to tighten.