Tapering postponed

by: Peter de Bruin

  • FOMC members were not convinced that the recovery was on a strong enough footing to taper…
  • …while Chairman Bernanke was less confident about a move ´later this year´
  •  Crucially, financial markets saw the Fed´s delay as positive to the growth outlook
  • Indeed, an accelerating economy should eventually prompt the Fed to act in December

FOMC members delay tapering,…

Against expectations, the Fed decided to keep its asset purchase programmes unchanged at $85bn a month. In contrast, markets had widely anticipated that the Fed would reduce the pace of its asset purchases, though expectations had been scaled back after August soft labour market report. Admittedly, the post-meeting statement continued to state that economic activity had been expanding at a ‘moderate pace’, though members wanted to see more evidence that progress will be sustained before adjusting the pace of purchases. In addition, the Committee is clearly worried about the recent tightening of financial conditions, which, if sustained, ‘could slow the pace of improvement in the economy and labor market’. Finally, the tapering decision was delayed because FOMC members were afraid that fiscal retrenchment could hurt the growth outlook too much, while they also feared that the upcoming fiscal debates about extending the continuing resolution and raising the debt ceiling could pose additional downside risks to growth.

 

…and sound less certain about a move later in the year…

Meanwhile, Chairman Ben Bernanke, in the press conference after the meeting, seemed to be less confident that the Fed will start to taper its QE programmes in coming months. Indeed, although a reduction in the Fed’s programmes was possible ‘later this year’, there was no ‘fixed calendar schedule’. Moreover, in contrast to June’s meeting when Bernanke had signalled that he expected the Fed to have completely unwound its QE programmes when the unemployment rate would have dropped to 7%, the Chairman now said that this was just an indication and that there was no ‘magic number’.

 

…while downgrading their economic projections

Furthermore, FOMC members lowered their economic forecasts. Indeed, the midpoint for 2013 GDP growth was now estimated at 2.2%, instead of 2.5% in June, while the growth forecast for 2014 was lowered from 3.3% to 3.0%. Growth in 2015 though, was kept unchanged at a midpoint of 3.3% and members saw growth in 2016 ranging between 2.5% and 3.3%. Interestingly, the unemployment rate in the final quarter of that year was expected to be between 5.4% and 5.9%, which is close to the Fed’s long-run unemployment rate estimates. Theoretically, monetary policy should be neutral, with a federal funds rate around 4%, when the unemployment rate reaches its long-run level, though FOMC members´ median projection of the Fed´s policy rate is only 2% at the end of 2016. This makes it clear that the Fed is not following a Taylor rule as the economy is recovering from the deepest crisis since WWII. For now, with inflation being low, this is not a problem, but it could cause problems further down the road. Indeed, we think that there is less slack in the economy than what the Fed estimates, which explains why we expect to see more rate hikes in 2015 and 2016.

 

Smart economics, bad communication

Although we were of the view that the build-up of market expectations would leave the Fed with no other choice but to take a first step, we view a delay of the Fed´s tapering decision as positive for the economic outlook and growth assets, as it shows that the central bank is determined to support the recovery and to prevent a premature tightening in financial conditions. That said, while we think that an acceleration in growth in the remainder of the year will prompt the Fed to eventually act in December, it is clear that the central bank is currently not scoring high marks on its ability to communicate with financial markets.