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Quick wrap-up:
- No change in policy rates, quantitative easing (QE) concludes as scheduled
- The Fed kept the “considerable time” phrase in its policy statement
- The assessment of the labor market was more upbeat
- There was a hawkish tilt in the tone of the press statement, compared to recent press statements
1. Done with QE….for the time being
We are done with QE, at least for the time being. I think the threshold is high for another round of QE, because another round would certainly be controversial.The Fed said it will continue to reinvest maturing mortgage-backed securities (MBS) and maturing agency securities into fresh MBS, and maturing Treasurys into fresh Treasurys. The Fed views that the large size of its balance sheet “should help maintain accommodative financial conditions.”
2. Forward guidance unchanged
The forward guidance was just about the same as in recent meetings, as I believe the FOMC was worried about the market reaction to a change in the wording in current volatile markets.
A notable quote:
It likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program this month, 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.”
3. When will the Fed hike rates?
The FOMC repeated an important warning:
The Committee currently anticipates 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.”
But it sent a contrary signal at the same time by saying:
For the first time, I felt like the Fed was sending “a warning shot across the bow” of the market. It reads like a symmetric statement. The market might get it wrong in either direction, depending on how the economy goes. Fair enough. But to me, the real warning seems to be that tightening could start sooner than currently priced into markets. The Fed did not say any such thing any time in the past 7 years.…if incoming information indicates faster progress toward the Committee's employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.”
4. “Moderate” economic growth
The description of economic growth was muted, referring to “moderate” growth. But there were some significant changes in phrases. Instead of saying the labor market “improved somewhat” and that “there remains significant underutilization of labor resources,” the statement referred to “solid job gains and a lower unemployment rate” and said that the “underutilization of labor resources is gradually diminishing.”
The press statement also said: “The Committee judges that there has been a substantial improvement in the outlook for the labor market since the inception of its current asset purchase program.”
5. The Fed downplayed deflation risks in the US
The inflation description and assessment was modified to acknowledge lower energy prices: “Although inflation in the near term will likely be held down by lower energy prices and other factors, the Committee judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year.”
It seems the Fed found it necessary to emphasize that “core” inflation is its near-term inflation measure, and the Fed is saying it, unlike the ECB and the Riksbank, does not see deflation risks. While the Fed is fully aware of the consequences of the stronger US dollar, the Fed consistently refuses to make any reference to the exchange rate on the grounds that dollar policy is the province of the US Treasury.
The Fed rarely says anything about inflation expectations easing, even when they have, because to acknowledge the fact would require that the Fed take action. The Fed today walked a fine line on this issue. I found this very striking and I suspect that some of the dovish members of the FOMC (especially Minneapolis’s Kocherlakota) were assertive that this was an issue.
The statement said: “Inflation has continued to run below the Committee's longer-run objective. Market-based measures of inflation compensation have declined somewhat; survey-based measures of longer-term inflation expectations have remained stable.”
Put another way, whatever the TIPS market is saying, the Fed isn’t believing it. The Fed continues to assert that long-term inflation expectations are stable. We shall see.
What do we expect from the December FOMC meeting?
In December, there will be a fresh Survey of Economic Projections, and Federal Reserve Chair Yellen will hold a press conference. I expect there will be no policy rate hikes, but the policy statement and forward guidance should start to signal the upcoming shift in Fed policy. “Considerable time” is likely to be replaced with different forward guidance.
Source: Federal Reserve issues FOMC statement, October 29, 2014
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