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Janet Yellen weighed in on forward guidance and the Fed taper

Phalguni Soni

Janet Yellen's speech hints on what the Fed dashboard looks like (Part 7 of 9)

(Continued from Part 6)

The recent FOMC communication

Janet Yellen spoke on monetary policy and economic recovery at The Economic Club of New York on Wednesday, April 16. In the last part, we discussed her take on monetary policy challenges, the role of qualitative and quantitative forward guidance since the Great Recession, and the recovery. In this part, we will discuss the recent FOMC communication with respect to asset purchases and the Fed taper.

In its last monetary stimulus effort (QE3) launched in the fall of 2012, the Fed explicitly tied the program’s trajectory to evolving economic conditions. Accordingly, based on economic progress made, the Fed began scaling back its monthly bond buying program of longer-term Treasuries (TLT) and agency-backed securities (MBB). From an initial level of $85 billion per month, the monthly purchases now stand at $55 billion per month due to reduction of $10 billion per month announced at each of the last three FOMC meetings, starting December 2013.

However, the Fed explicitly points out that “If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-term objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.”

Reducing purchases of longer-term Treasuries and agency-backed securities would impact negatively impact demand and prices for these securities, all else equal. This would impact ETFs like the iShares 20+ Year Treasury Bond ETF (TLT), iShares 10-20 Year Treasury Bond (TLH), the iShares Barclays MBS Fixed-Rate Bond Fund (MBB), and the Vanguard Mortgage-Backed Securities Index Fund (VMBS). Short-term money market funds like the State Street SPDR Barclays 1-3 T-Bill ETF (BIL) are less likely to be affected unless the base rate undergoes a change.

In the next couple of parts, we will discuss the rationale for the Fed’s new forward guidance policy, and why this is important for ETF investors.

Continue to Part 8

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