No tapering, more tampering leads to more questions than answers at the FED. So much for forward guidance.
Despite clear indications “Tapering” may begin in the Fall, the Fed decided to continue the process of QE, purchasing mortgage backed securities at a pace of $40 billion per month and longer term Treasury securities at the rate of $45 billion per month, this week.
The objective - to maintain downward pressure on longer term interest rates to support mortgage markets, a fragile housing recovery and to make broader financial conditions more accommodative in the short term, In that way, growth plans for the US economy are not derailed in the recovery phase.
The Federal Open Market Committee had been concerned by the rapid rise in ten year Treasury rates by 120 basis points and evidence of low inflation and slightly weaker jobs market. Furthermore, fiscal consolidation and a higher tax burden were likely to damage growth this year. The FOMC reduced their own forecasts for 2013 to around 2.1% from 2.4% in the July review, as a result of recent developments.
Should we be surprised by the decision?
Should we be surprised by the decision? Well yes and no. In July the mood was more optimistic about the economy. The US economy was expected to growth by almost 2.4% in 2013 and by 3.3% next year. Unemployment was expected to fall towards 7% this year, then down to 6.5% next. Inflation was expected to average around 1.5% next year, with no obvious inflation threat on the horizon. The surprising thing is the revised forecasts haven’t changed the medium term outlook over much. The US recovery is still on track. The growth forecasts have been reduced to a more realistic level for the current year. We still think the USA will struggle to hit the 2% mark but nothing has changed of late to alter that view.
So what’s changed?
So what’s changed. The FOMC committee has been disturbed by the rally in long rates and the rise in ten year Treasury yields towards 3%. The labour market has seen moderate growth but no reason of itself to step back from tapering. Bernanke’s phone line must have been ringing off the hook by calls from central bankers in emerging markets. Faced with the repatriation of hot monies to the USA, capital outflows and plummeting exchange rates, Brazil, India, South Africa, Indonesia, Turkey and more have confronted the realignment of the US yield curve to some semblance of normality but not without some considerable cost to their own domestic economies. The BISTO kids would have welcomed the continuation of the QE gravy train for now.
For the Fed and Bernanke, there is no fall back. They have to get the timing right to begin to tighten policy. “Monetary shocks played a major role in the Great Depression” said Bernanke in Essays on the Great Depression :Princeton 2000 and “Much of Japan’s [lost decade] can be attributed to exceptionally poor monetary policy making” writing in "Japanese monetary policy, A Case of Self Induced Paralysis Princeton in 1999. The Fed cannot be seen to move too soon and damage the recovery. Bernanke would rather hold the patient a little longer on life support, than allow the economy and the markets, to leave intensive care too soon.
Will a few months or so make much difference? Not really, sooner or later, and better sooner, QE must be drawn to a close in the USA.
What about Base Rates?
Despite the delay on tapering, the FOMC believe base rates will be on the rise in 2015 towards 1%. The labour market is likely to hit the 6.5% hurdle rate at some stage next year. The tapering process may begin by the end of the current year or may await the cosmic flip from Planet ZIRP to Planet Janet in January. (Assuming Janet Yellen takes over as lead astronaut at the Fed early in the New Year.)
By 2016, US rates are expected to rise to 2% on their way back to a 4% norm over the medium term. Indeed 20% of the fed votes would expect rates to be back at 4% by 2016.
So what does this mean for the UK. Our guideline is watch the US and add six months. Fed rates are expected to remain on hold until the end of 2014, rising in 2015 to 1%. By 2016, they may be at 2% or above.
In the UK, the MPC’s forward guidance suggests rates may be on hold for three years until 2016. That’s a long way off. For the moment, the decision not to taper but to continue to tamper, will please the markets but only in the short term. The traders will find a reason to test the Fed towards the end of the year. Tapering is coming and so are the rate rises in the USA and the UK.
Posted by John Ashcroft.
Keywords, Forward Guidance, Tapering, QE, FOMC, Bernanke.
© 2013 John Ashcroft, The Saturday Economist, John Ashcroft and Company.
The material is based upon information which we consider to be reliable but we do not represent that it is accurate or complete and it should not be relied upon as such. We accept no liability for errors, or omissions of opinion or fact. In particular, no reliance should be placed on the comments on trends in financial markets.
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The material is based upon information which we consider to be reliable but we do not represent that it is accurate or complete and it should not be relied upon as such. We accept no liability for errors, or omissions of opinion or fact. In particular, no reliance should be placed on the comments on trends in financial markets. The presentation should not be construed as the giving of investment advice.