Oct 2 2013 - Rise in Rates, Debt Ceiling Debate Put Tapering on Hold
Fed Keeps Purchase Program at $85 bln
The FOMC decided to hold off on a tapering announcement at its September meeting. It did so primarily on two grounds:
- A desire to wait on further economic data to see if it confirms that economic progress is being sustained and
- Concerns about upcoming policy discussions on the budget and the debt ceiling that it says present economic risks.
The consensus view was that the Fed would announce a "light taper" today (i.e. a $10-15 bln cut in its asset purchase program). While doing nothing was certainly warranted based on the data since the last FOMC meeting on July 31, today's decision to hold steady was nonetheless a surprise for the market.
Following the decision, the Dow, S&P 500, and Russell 2000 all spiked to new record highs, gold and oil prices skyrocketed, and Treasury yields dropped sharply. The moves were material and can certainly be thought of as a "pain trade" for those participants who were positioned for the Fed to adhere to the consensus view.
Asked at his press conference whether the Fed was concerned about sending the market mixed signals, Fed Chairman Bernanke declared the Fed is going to do what it thinks is best for the economy and should not let the market dictate its actions. We suspect that was a preset response given that the Fed certainly looked like it was pandering to the market's actions following the June meeting when one official after the next tried to calm the market after Mr. Bernanke provided a confusing message about a potential tapering timeline. This time we thought the Fed chairman did a much better job of communicating the Fed's message. Points of emphasis included the following:
- Asset purchases are not on a preset course.
- They are conditional on the data and always have been.
- There is no fixed calendar schedule for tapering.
- The unemployment rate is not a perfect indicator; hence, the Fed is looking at the overall labor market.
- It is quite possible that the fed funds rate will remain at the zero bound even after the unemployment rate moves below 6.5%.
- The committee is discussing how it could possibly clarify its fed funds rate guidance in relation to its inflation floor.
- The committee is concerned about the impact of fiscal headwinds on the economy.
- The Fed's policy is intended to create a stronger US economy and that strength in the US is the most important thing that could happen for emerging markets.
In conjunction with today's decision, the Fed updated its economic projections. Strikingly, there was a bit of a mismatch in the language in the directive and the forecast for real GDP growth. Specifically, the directive acknowledged that economic activity has been expanding at a moderate pace since the committee met in July. At the prior meeting, it was noted that economic activity expanded at a "modest" pace during the first half of the year. Notwithstanding the verbal upgrade, projections for real GDP growth in 2013 and 2014 were lowered from the projections provided in June.
The central tendency for real GDP growth in 2013 was cut from 2.3% to 2.6% to 2.0% to 2.3%. For 2014, it was lowered from 3.0% to 3.5% to 2.9% to 3.1%.
The Fed of course has regularly been too optimistic with its GDP growth projections. If nothing else, the downgrade this time around provides a reminder that the fed funds rate certainly isn't going to be raised anytime soon. To that end, 12 of the 17 FOMC participants think the first rate hike won't occur until 2015 while two think it will wait until 2016.
The "lower for longer" messaging was music to the ears of the stock market. However, in due time we expect to hear growing concerns about the Fed increasing the risk of asset bubbles forming and the added challenges it is creating in managing its exit strategy and the market's expectations pertaining to that strategy.
Regrettably, the market will continue to be stuck with the question as to when the Fed is likely to start tapering its asset purchases. The answer repeated again and again by the Fed chairman is that the Fed will be data dependent in making that determination. That is actually a vague perspective, yet it was clear by the market's response that it is happy to know the Fed isn't taking its foot off the gas pedal just yet. That's owed in part to the fact that Congress continues to tap the breaks with its fiscal policy and partisan bickering. Says have tools to manage interest rates and unwind balance sheet when the time comes; comfortable it can raise rates at the appropriate time...
Fed Chairman Ben Bernanke Press Conference Highlights
- On Emerging Markets (EEM), Fed Chairman Ben Bernanke said the committee always looks at International aspects of impact on emerging markets; says problems in any emerging market can impact the U.S.; trying to create a stronger U.S. economy with asset purchase program which is a big positive for emerging markets...
- Said fiscal policy decisions did concern members; notes its ability to offset fiscal concerns is limited...
- Notes downward trend in participation rate in the labor force...
- Emphasizes no preset schedule for tapering...
- Declines to comment on succession...
- Says there are 8 meetings of note; says if there was a decision made that necessitates a press conference it would do so...
- Reiterates targets are thresholds not triggers; says committee unlikely to cut asset purchases if inflation remains below target; says first cuts may not happen for some time even if unemployment hits 6.5%...
- Notes prior comments that conditions pointed toward potential tapering but notes it made clear that conditions would be on receipt of evidence of a sustainable recovery Says broad contour of medium economic outlook were close to the views it held in June but still did not have confirmation that would allow it to move forward...
- Says rate rise has slowed economic growth by a 'percentage point or more'...
- 'conditions in labor market are still far from what all of us would like to see'..
- Generally outlook for most on the committee is moderate economic growth that will pick up over time...
- Tightening conditions, if sustained, could slow pace of recovery; notes fiscal policy also downside risk...
- Sees continued but uneven improvement in labor market; jobs still remain unsatisfactory...
Notable Changes to Fed Statement
- Sept 18: Information received since the Federal Open Market Committee met in July suggests that economic activity has been expanding at a moderate pace...Changes: A slight upgrade from the 'modest' language used in July.
- Sept 18: Some indicators of labor market conditions have shown further improvement in recent months, but the unemployment rate remains elevated... Changes: Added in 'some' which is a nod to some of the underlying metrics being weaker which was a theme in some speeches the past few weeks.
- Sept 18: Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen further and fiscal policy is restraining economic growth... Changes: Took out 'somewhat risen' to clearly point toward that they have risen.
- Sept 18: Apart from fluctuations due to changes in energy prices, inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable... Changes: Specifically mention energy prices here.
- Sept 18: Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall, but the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term... Remains the same.
- Sept 18: Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. ... Changes: This has been added in to explain todays action.
- Sept 18: The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. In judging when to moderate the pace of asset purchases, the Committee will, at its coming meetings, assess whether incoming information continues to support the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective... Remains the same.
- Sept 18: Comments on targets remains the same.
Economic Projections from September Meeting
| Fed Economic Projections (central tendencies as of September 2013) |
| |
2013 |
2014 |
2015 |
2016 |
Long Run |
| Change in real GDP |
2.0 to 2.3 |
2.9 to 3.1 |
2.9 to 3.6 |
3.0 to 3.5 |
2.2 to 2.5 |
| June projection |
2.3 to 2.6 |
3.0 to 3.5 |
2.9 to 3.6 |
N/A |
2.3 to 2.5 |
| Unemployment rate |
7.1 to 7.3 |
6.4 to 6.8 |
5.9 to 6.2 |
5.4 to 5.9 |
5.2 to 5.8 |
| June projection |
7.2 to 7.3 |
6.5 to 6.8 |
5.8 to 6.2 |
N/A |
5.2 to 6.0 |
| PCE inflation |
1.1 to 1.2 |
1.3 to 1.8 |
1.6 to 2.0 |
1.7 to 2.0 |
2.0 |
| June projection |
0.8 to 1.2 |
1.4 to 2.0 |
1.6 to 2.0 |
N/A |
2.0 |
| Core PCE inflation |
1.2 to 1.3 |
1.5 to 1.7 |
1.7 to 2.0 |
1.9 to 2.0 |
|
| June projection |
1.2 to 1.3 |
1.5 to 1.8 |
1.7 to 2.0 |
N/A |
|
