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Fed Brief

Apr 23 2014 - The Pitfalls of Defining 'Considerable amount of time'

Market Dips on '6 month' Comments

Equity markets saw two sell offs. One following the release of the FOMC in which the 'dots' showed a more aggressive potential for rate hikes. The second during Fed Chair Janet Yellen's statement in which she made an off the cuff remark and defined considerable amount of time as '6 months'. The market viewed this as a defined date for when the Fed would raise rates. What was ignored was the statement that followed in which she noted that the final decision would depend on the environment. As per usual, the Fed remains data dependent. However a definition garnered attention and set off selling programs. 

The knee-jerk reaction to the latest policy communication from the FOMC was negative in both the stock and bond markets. The Treasury market response was more interesting. At first blush, it might be interpreted as concerns that the Fed risks inviting too much inflation by keeping rates too low for too long. Gold prices, however, didn't respond to such a view as they fell to session lows after the FOMC announcement. Therefore, with the commensurate spike in the US Dollar Index one would have to extrapolate that the weakness is owed more to concerns that interest rates will be moving higher sooner rather than later.

In response to a question as to what the Fed means by "considerable time" for keeping the current target range for the federal funds rate after the asset purchase program ends, Fed Chair Yellen said "probably six months." Selling activity accelerated after the remark, although at the current pace of tapering, and with six FOMC meetings remaining this year, that would hold reasonably close to the market's prevailing expectation that the first rate hike won't occur until the latter half of 2015.

Perhaps, then, the negative reactions are just a byproduct of the vagueness of qualitative guidance or it could simply be some disappointment that the markets have not responded favorably to Fed Chair Yellen's first turn at the press conference. It's probably better not to read too much into the initial responses, especially since the main message remains that the fed funds rate is going to remain very accommodative for a long time if the economy keeps tracking in its new normal way. To that end, the spike seen today in the 10-yr note yield (-28/32 at 2.775%) isn't the most welcome development for the housing market.

Change at the Fed

One thing is clear about the latest policy directive from the FOMC. It is not Ben Bernanke's directive. It is Janet Yellen's directive. Gone is the attention to a 6.5% unemployment rate threshold for determining the possible timing of a first rate hike in the federal funds rate and in is a shift to a more qualitative read on things. The directive acknowledged, as before, that a wide range of measures will be looked at, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. However, the latest directive stipulated that the Committee will assess progress -- both realized and expected -- toward its objectives of maximum employment and 2 percent inflation. Said another way, the FOMC will be using some intuition when it comes to meeting its dual mandate; hence, the attention to "expected" progress.

Perhaps the most important takeaway, though, is that the directive states it will likely be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.

With respect to the asset purchase program, the FOMC elected to trim its monthly purchases by another $10 bln to $55 bln, with $25 bln per month in agency mortgage-backed securities and $30 bln per month of longer-term Treasuries. This was not a surprise as Fed officials have been stressing that the bar for a change in this tapering path remains high.

The directive did note that growth in economic activity slowed during the winter months, in part reflecting adverse weather conditions. The "in part" portion was striking because it does suggest an acknowledgment that the slowdown was not just because of the weather.

The central tendency of the projection for real GDP growth for 2013 was revised from 2.8% to 3.2% to 2.8% to 3.0%. The upper end of central tendency projections for real GDP growth in 2015 (3.0 to 3.2) and 2016 (2.5 to 3.0) were also lowered by 0.2 each. The central tendency projections for PCE and core PCE inflation were left largely unchanged from the December meeting. Importantly, those projections don't surpass 2.0% for the forecast period. Central tendency projections for the unemployment rate, however, were revised down for 2014, 2015, and 2016. It's an interesting view in that the unemployment rate is expected to come down, yet the projections for PCE inflation have not been raised. Moving back to the directive, it stated that, 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.

On that note, 13 out of 17 Fed officials don't expect the first bump in the fed funds rate until 2015 versus 12 out of 17 at the December meeting. At the December meeting, though, 12 officials felt the appropriate level of the fed funds rate at the end of calendar 2015 would be 1.0% or less. That edged down to 11 officials at the March meeting.

Fed Chair Yellen Conference Call  Highlights

-- Cchange in forward guidance does not change Fed direction.
-- Weather has made assessing strength of the economy 'especially challenging'.
-- Sufficient strength in economy to support improvement in the labor market.
-- Committee believes forward guidance has been effective. Says market wants to understand beyond when a threshold is met; says this change was done to provide further information on the Fed's outlook.
-- Fed knows it is not close to meeting its jobs mandate; says the Unemployment Rate is a good indicator but does not provide a full picture.
-- Asked about slight upward drift for rate expectations- says todays assessment with December is 'virtually identical'; notes Fed member shave expressed a number of opinions on the likelihood of the direction of rates...feels confident it can keep inflation from undershooting targets.
-- Yellen reiterates next Fall remains time frame for ending QE.
-- Weather not only factor hurting economy.
-- Incoming data since January has been slightly lower, partly because of weather, partly because it may have gotten ahead of itself and been more positive than it should have been in January.
-- Continues to see substantial slack in labor department; has not faced a trade off with unemployment and inflation.
-- In terms of Ukraine situation, it is something that they are monitoring closely; discussed in meeting with regards to direct trade exposures; does not have a large trade or bank connections with either country; says geopolitical risks that they need to be attentive to; says not seeing any economic pressure yet but if this was to escalate it would be something that needs to be addressed.

Notable Changes to FOMC Statement

-- March 19- indicates that growth in economic activity slowed during the winter months, in part reflecting adverse weather conditions... January 29- indicates that growth in economic activity picked up in recent quarters.
-- March 19- takes out that unemployment rate declined; keeps rates remain elevated language.
-- March 19- A little more cautious on housing as it says that the housing sector remained slow compared to 'slow somewhat' in January.
-- March 19- The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions... Jan 19- Taking into account the extent of federal fiscal retrenchment since the inception of its current asset purchase program, the Committee continues to see the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy.
-- March 19- Another $10 bln taper, as expected and noted in asset purchase amounts (now down to $55 bln a month); continues language with intent on holdings.
-- March 19- Reiterates 'appropriate' language.
-- Forward Guidance- Changes it to reflect the turn away from the 6.5% Unemployment threshold.
-- Voters- Kocherlakota dissented from paragraph 5: "To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored".

Economic Projections from March Meeting

Fed Economic Projections (central tendencies as of March 2014)
  2014 2015 2016 Long Run
Change in real GDP 2.8 to 3.0 3.0 to 3.2 2.5 to 3.0 2.2 to 2.3
Dec projection 2.8 to 3.2 3.0 to 3.4 2.5 to 3.2     2.2 to 2.4     
Unemployment rate 6.1 to 6.3     5.6 to 5.9     5.2 to 5.6     5.2 to 5.6
Dec projection 6.3 to 6.6     5.8 to 6.1     5.3 to 5.8     5.2 to 5.8     
PCE inflation 1.5 to 1.6     1.5 to 2.0     1.7 to 2.0     2.0     
Dec projection 1.4 to 1.6     1.5 to 2.0     1.7 to 2.0     2.0     
Core PCE inflation 1.4 to 1.6     1.7 to 2.0     1.8 to 2.0     
Sept projection 1.4 to 1.6     1.6 to 2.0     1.8 to 2.0     

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