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The FOMC Minutes Confirm That The Probability of “Tapering” In 2013 Is Less Than 50%

- Christophe Barraud

 

Last night, I read the FOMC Minutes and I didn’t see any change regarding the Fed Communication which suggests that “tapering” will occur soon (in 2013). This morning, this opinion was not shared by the financial press which underlines that some Fed members would have preferred to taper in September and that the status quo could potentially undermine the Fed’s credibility.

 

The fact is that contrary to many economists and journalists, I’m able to make the difference between arguments from voters (who backed “no taper” at 9/1 in September) and non-voters (who are far more “hawkish”)

 

We could isolate some excerpts on asset purchases from the FOMC Minutes:

 

In their discussion of the path for monetary policy, participants debated the advantages and disadvantages of reducing the pace of the Committee’s asset purchases at this meeting, focusing importantly on whether the conditions presented to the public in June for reducing the pace of asset purchases had yet been met. In general, those who preferred to maintain for now the pace of purchases viewed incoming data as having been on the disappointing side and, despite clear improvements in labor market conditions since the purchase program’s inception in September 2012, were not yet adequately confident of continued progress. Many of these participants had revised down their forecasts for economic activity or pointed to near-term risks and uncertainties. For example, questions were raised about the effects on the housing sector and on the broader economy of the tightening in financial conditions in recent months, as well as about the considerable risks surrounding fiscal policy. Moreover, the announcement of a reduction in asset purchases at this meeting might trigger an additional, unwarranted tightening of financial conditions, perhaps because markets would read such an announcement as signaling the Committee’s willingness, notwithstanding mixed recent data, to take an initial step toward exit from its highly accommodative policy. As a result of such concerns, a number of participants thought that risk-management considerations called for a cautious approach and that, in light of the ambiguous cast of recent readings on the economy, it would be prudent to await further evidence of progress before reducing the pace of asset purchases. Consistent with the framework discussed by the Chairman during the June press conference, asset purchases were contingent on the Committee’s ongoing assessment of the economic outlook and were not on a preset course; this approach implied a need to adapt and to adjust asset purchases in response to changes in economic conditions in order to preserve the Committee’s credibility.

 

This excerpt is absolutely coherent with last voters’ speeches (excluding Esther George). As an example, I selected some headlines from my archives:

 

***On September 18 – Fed Chairman Bernanke (dove, FOMC voter) / Economic data does not yet warrant a reduction in asset purchases; To await further evidence of recovery.
- Bernanke commented that the Fed is concerned about economy and wanted to observe the effects of higher interest rates before making adjustments to QE.
- Primary reasons for central fed fund rate forecast being at 2% for 2016 unusually low when other economic indicators are expected to be more normalized, are current headwinds that could still persist including the slow recovery in housing sector, and continued fiscal drag.

 

***On September 20 – Fed’s Bullard (moderate, FOMC voter) / The economy is not that fragile, but there has been some weaker data.
- Wants to see a recovery in inflation before adjusting stimulus program, inflation is expected to rise over the upcoming quarters.

 

***On September 23 – Fed’s Dudley (dove, FOMC voter) / Labor market improvements have likely been overstated.
- Fiscal drag and current market interest rates are a drag on growth.
- Fiscal uncertainty is one issue impacting the schedule for exiting QE, along with market interest rates and less good data.

 

***On September 26 – Fed’s Stein (dove, FOMC voter) / Sept decision against taper was ‘close’.

 

***On September 27 – Fed’s Evans (dove, FOMC voter) / Need more confidence in GDP to taper.

 

***On October 2 – Fed’s Rosengren (dove, FOMC voter) / Strongly backed FOMC’s decision not to taper QE at the Sept meeting.
- Fed should only remove accommodation when employment and GDP recover.
- Must be prepared to offer more accommodation if needed.

 

Other voters (excluding Esther George) have not made any speeches concerning economic activity and QE following the September FOMC meeting. However, everybody knows that Janet Yellen and Jerome Powell are very “dovish” and therefore they strongly supported the decision to let the asset purchase program unchanged in September.

 

At the opposite, I can’t deny that some members urge to reduce the asset purchase program as soon as possible:

 

The participants who spoke in favor of moderating the pace of securities purchases at this meeting also cited the incoming data, but viewed those data as broadly consistent with the Committee’s outlook for the labor market at the time of the June FOMC meeting when the contingent expectation that the pace of asset purchases would be reduced later in the year was first presented to the public. Moreover, they highlighted what they saw as meaningful cumulative progress in labor market conditions since the purchase program began. Those participants generally were satisfied that investors had come to understand the data-dependent nature of the Committee’s thinking about asset purchases, and, because they judged that the conditions laid out in June had been met, they believed that the credibility of the Committee would best be served by announcing a downward adjustment in asset purchases at this meeting. With the markets apparently viewing a cut in purchases as the most likely outcome, it was noted that the postponement of such an announcement to later in the year or beyond could have significant implications for the effectiveness of Committee communications. In particular, concerns were expressed that a delay could potentially undermine the credibility or predictability of monetary policy by, for example, increasing uncertainty about the Committee’s reaction function and about its commitment to the forward guidance for the federal funds rate, with the result of an increase in volatility in financial markets. Moreover, maintaining the pace of purchases could be perceived as a sign that the FOMC had turned more pessimistic about the economic outlook. Finally, it was noted that if the Committee did not pare back its purchases in these circumstances, it might be difficult to explain a cut in coming months, absent clearly stronger data on the economy and a swift resolution of federal fiscal uncertainties. Most of the participants leaning toward a downward adjustment in the pace of asset purchases also indicated that they favored a relatively small reduction to signal the Committee’s intention to proceed cautiously.

 

These findings were only reported by Esther George and other Fed members who are non-voters as we can see below:

 

***On September 26 – Fed’s Lacker (hawk, FOMC non-voter) / Would be difficult to start taper in Oct without losing face (but its could be done in principle based on data), but don’t see any reason why the taper can’t start in Dec.

 

***On September 27 – Fed’s George (hawk, FOMC voter) / Decision not to taper bond buying could threaten credibility of future Policy.
- Disappointed by decision not to taper, US economic fundamentals have improved substantially.
- Delaying action could lead market to wrongly judge that Fed has become more pessimistic on economic outlook.
- Fed should lay out clear plan about taper start time.

 

***On September 30 – Fed’s Plosser (hawk, FOMC non-voter) / FOMC undercut the credibility of its own forward guidance, September’s non-action calls the unemployment thresholds into doubt.

 

***On October 3 – Fed’s Fisher (hawk, FOMC non-voter) / Fed is contributing to economic uncertainties.

 

***On October 4 – Fed’s Lacker (hawk, FOMC non-voter) / Would have voted to taper even if he had known the US was headed for a two-week govt shutdown.
– Labor market conditions have improved substantially since the Fed began QE.

 

***On October 8 – Fed’s Plosser (hawk, FOMC non-voter) / Time has come to expeditously phase out the QE program; economy is expanding at 2.5% this year, next year should grow at 3%.

 

To sum up, for me, it’s clear that voters are more cautious than non-voters concerning both employment, growth and inflation. In the meantime, the “government shutdown” has a negative impact on Q4 GDP so that growth forecasts set in September should be at risk. Moreover, the slowing of growth means less inflationary pressures in a context where we are far below the 2% target. Finally, the latest employment figures (ADP, employment component of ISM services, Intuit Survey, Challenger Job Cuts and now Initial claims) suggest a weaker trend. As a consequence, “Octaper” is very unlikely.

 

Now, if we focus on December, I think that the probability of “tapering” is less than 50% for different reasons:
 
1/ The Employment report for October and November will be affected by the “government shutdown” an could lead to a wrong interpretation.
2/ Q3 and Q4 GDP should be weak so that Fed could revise downward its growth forecast for 2013 and maybe 2014.
3/ Inflation will not bounce back immediatly.
4/ Even if Democrats and Republicans are able to find a temporary compromise on the continuing resolution, another “government shutdown” is possible at the end of the year. Indeed, it will be very difficult for politicians to define the amount of new budget cuts and their affectations (civil – defense) for 2014.
 

Finally, I would like to note that the only error of the Fed concerning its communication is to let speaking non-voters too often so that it could lead investors to make mistakes.

As I Expected, Fed Refrains From “Tapering”

As I expected, the Fed refrains from “tapering” as economic data did not show sufficient improvement of the economy. The Fed notes that since the last FOMC meeting,  mortgage rates have risen further, the unemployment rate has remained elevated,  inflation has been persistently below its 2 percent objective and fiscal policy is restraining economic growth.

 

Some extracts from the Fed:

 

Information received since the Federal Open Market Committee met in July suggests that economic activity has been expanding at a moderate pace. Some indicators of labor market conditions have shown further improvement in recent months, but the unemployment rate remains elevated. 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. 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.
 
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. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.

 
In this context, the Fed reviseD downward its growth and inflation forecasts. Moreover, as far as the appropriate timing of rates’ hike, the participants moved out a little with two participants now seeing the first increase in 2016.

 

Economic Forecasts:
 
1/ GDP:
- 2013 GDP 2.0-2.3% (prior 2.3-2.6%)
- 2014 GDP 2.9-3.1% (prior 3.0-3.5%)
- 2015 GDP 3.0-3.5% (prior 2.9-3.6%)
- Initial 2016 2.5-3.3%
- Longer run GDP 2.2-2.5% (prior 2.3-2.5%)

 

2/ PCE inflation:
- 2013 1.1-1.2% (prior 0.8-1.2%)
- 2014 1.3-1.8% (prior 1.4-2.0%)
- 2015 1.6-2.0% (prior 1.6-2.0%)
- Initial 2016 1.7-2.0%

 

3/ Rate Path:
- 0 officials sees first hike in 2013 (1 prior)
- 3 see first hike in 2014 (3 prior)
- 12 officials see first hike in 2015 (14 prior)
- 2 sees first hike in 2016 (1 prior)

 

Finally, at the press conference, Bernanke insisted on rates and was “very dovish” underlining that:
 
1/ Rates increases possibly may not occur until unemployment is considerably below the 6.5% level.
2/ Unlikely to raise rates if inflation remained well below 2% target for some time.
3/ Even after QE is wound down, Fed rate policy and large balance sheet will promote highly accommodative policy for some time.
 
The most important point is that Bernanke acknowledges that some of the recent decline in unemployment rate has been due in part to lower participation rate. Despite a downward trend in participation rate due to aging population, there is a cyclical component to labor participation rate which means that a lot of people could come back on the labor market.

Eight Reasons Why the Fed Will Not “Taper” in September (An Update)

Just before the FOMC statement on September 18, I think it’s interesting to make an update of my post concerning arguments against “tapering”.

 

Indeed, notwithstanding the fact that the expansionary Fed policy poses risks to financial markets’ stability, especially with the increasing volume of speculative positions (corporate high yield, jumbo loans…), at least eight reasons are still legitimizing a wait-and-see policy in the short term:

 

1/ The lack of short-term agreement on fiscal issues, more specifically on the “continuing resolution” and the 2014 budget. Currently, Republicans insist on keeping automatic budget cuts which will take effect during the 2014 fiscal year (starts on October 1st) and will reach $109B (0.6% of real GDP).

 

-> Senate Majority Leader Harry Reid said last Thursday that deep divisions within the House Republican caucus are imperiling passage of a fiscal year 2014 stop-gap spending bill and threaten both a government shutdown and a default. Note that this bill would keep the government funded until Dec 15 and should include sequestration of $109 billion.

 

2/ The threat of automatic budget cuts, which outcome would not be known from the end of September, comes at a time when growth has been low since the beginning of the year. Indeed, even with an upward revision of the 2Q GDP to 2.5% (QoQ annualized), GDP should increase by 3.1% in 3Q and 4Q to meet the projected 2013 growth defined by the Fed in June (ie 2.45% from 2012 4Q to 2013 4Q).

 

-> The last statistics (August retail sales, Wholesale inventories…) suggest that actual growth (3Q) is below 2%.

 

3/ The signals from the residential housing market are deteriorating. The recent rise in mortgage rates (highest since April 2011) weighed very negatively on refinancing activity (13 declines recorded in the last 16 weeks) but also on new home sales (-13.4% MoM in July). There is no doubt that existing home sales should fall in August, according to the pending home sales’ decline in July (-1.3% MoM).

 

-> Mortgage applications decreased 13.5 percent from one week earlier, according to data from the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey for the week ending September 6, 2013 (14 declines recorded in the last 17 weeks). The Refinance Index decreased 20 percent from the previous week and has fallen 71 percent from its recent peak (the week of May 3).

 

4/ Inflation is broadly in line (PCE inflation) or below (PCE Core Inflation) the Fed’s forecasts made in June. Anyway it remains well below the 2% target, which is the medium-term reference.

 

5/ Regarding the labor market, it must be recognized that since the set-up of the buyback program (September 2012), pace of nonfarm payrolls has improved whereas unemployment rate has decreased. However, the last report (August) underlines that the short term momentum of NFPs is weakening and is still below the threshold of 200K which is not a minimum acceptable for Fed:
-> Moving average 3 months: 148K
-> Moving average 4 months: 155K
-> Moving average 5 months: 164K
-> Moving average 6 months: 160K

- Also, as pointed out by the Fed members during the last Fed Minutes, qualitative indicators, namely the number of long-term unemployed (more than 27 weeks), the number of full-time jobs or the “underemployment rate”, are only improving slightly. Similarly, the decline in the unemployment rate is mainly explained by a fall of participation rate (lowest since Aug 1978) which is not a good thing.

 

6/ The Syrian conflict could create uncertainty to the extent that the debt ceiling has not been raised. The fact is that military action could increase public spending above expectations and therefore could reduce the time remaining to politicians to find a compromise. Currently, according to Treasury Secretary, the deadline sould be reached by mid-October.

 

-> A diplomatic breakthrough Saturday on securing and destroying Syria’s chemical weapons stockpile averted the threat of U.S. military action for the moment. It means that Syrian conflict is not a longer an argument against tapering.

 

7/ During the G20, IMF noted that currently emerging economies are seen as particularly vulnerable to a tightening of US monetary policy and recommended that policy makers be ready to handle a rise in financial instability. In this context, Fed could choose to give more time to other policy markers.

 

8/ Fed communaction: The Fed members have not yet defined criteria or thresholds which would impact the asset purchase program.

- Moreover, since last FOMC, almost all members (voters and non-voters) have instisted on the fact that “tapering” will be only dependent on data which were clearly weaker than expected. The last Beige Book comfirms that activity continued to expand at a modest to moderate pace during the reporting period of early July through late August.

- Finally, some people forget that voters are more “dovish” that non-voters and that they give less press interviews.

- All Fed members’ speeches concerning QE and economic activity since the last FOMC meeting (July 30-31) are available here.

 

To replace my argurment on Syrian conflict, I choose to focus on future changes at the head of the Fed.

 

8bis/ Changes at the head of the Fed in 2014. The next year, the voting members will be more “hawkish” with the arrival of Fisher (Dallas Fed President) and Plosser (Philadelphia Fed President). Therefore, knowing that committee in place in 2014 would quickly end the asset purchases program, the actual committee could delay “tapering” to compensate.

Eight Reasons Why the Fed Will Not “Taper” in September

Wide divergences among economists are felt in polls showing conflicting results concerning the evolution of Feds’ asset purchase program at the next FOMC meeting (Sept. 17-18). The latest poll (Sept. 6) published by Bloomberg suggests that a majority of economists are expecting a slowdown in the Fed buyback program in September:

 

The Fed will start to cut the monthly asset purchases at the Sept. 17-18 meeting, paring them by $10 billion, according to the median of 34 responses in a Bloomberg survey on Sept. 6, after the jobs data. That’s unchanged from an Aug. 9-13 poll.

 
However, the NABE (National Association of Business Economists) survey shows contradictory results to the extent that only 10% of economists expect “tapering” at the coming FOMC meeting:

 

The economists appear to be more cautious in their outlook than Wall Street banks and even some Fed officials that have looked to the central bank’s September 17-18 meeting as a point to begin easing the pace of bond purchases, currently at $85 billion a month.
 
Only 10% of 220 economists polled expect the wind down to start before the end of September. The survey found 39% expect the first tapering of purchases in the final three months of 2013 with the remainder saying the Fed will hold off at least until 2014.

 

Concerning the next FOMC meeting, my conviction remains the same since May 25, I do not expect any announcement about a slowdown in the Fed purchase program. Notwithstanding the fact that the expansionary Fed policy poses risks to financial markets’ stability, especially with the increasing volume of speculative positions (corporate high yield, jumbo loans…), at least eight reasons are legitimizing a wait-and-see policy in the short term:

 

1/ The lack of short-term agreement on fiscal issues, more specifically on the “continuing resolution” and the 2014 budget. Currently, Republicans insist on keeping automatic budget cuts which will take effect during the 2014 fiscal year (starts on October 1st) and will reach $109B (0.6% of real GDP).

 

2/ The threat of automatic budget cuts, which outcome would not be known from the end of September, comes at a time when growth has been low since the beginning of the year. Indeed, even with an upward revision of the 2Q GDP to 2.5% (QoQ annualized), GDP should increase by 3.1% in 3Q and 4Q to meet the projected 2013 growth defined by the Fed in June (ie 2.45% from 2012 4Q to 2013 4Q).
 

 

- Now, if we look at the latest statistics (retail sales, industrial production, durable goods orders…), the trend remains weak and thus far behind the Fed’s target which is partly linked to a slowdown of the buyback program. As a witness, here‘s what Bernanke said at the June press conference:

 

“If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year”

 

3/ The signals from the residential housing market are deteriorating. The recent rise in mortgage rates (highest since April 2011) weighed very negatively on refinancing activity (13 declines recorded in the last 16 weeks) but also on new home sales (-13.4% MoM in July). There is no doubt that existing home sales should fall in August, according to the pending home sales’ decline in July (-1.3% MoM).

 

4/ Inflation is broadly in line (PCE inflation) or below (PCE Core Inflation) the Fed’s forecasts made in June. Anyway it remains well below the 2% target, which is the medium-term reference.

 

5/ Regarding the labor market, it must be recognized that since the set-up of the buyback program (September 2012), pace of nonfarm payrolls has improved whereas unemployment rate has decreased. However, the last report (August) underlines that the short term momentum of NFPs is weakening and is still below the threshold of 200K which is not a minimum acceptable for Fed:
-> Moving average 3 months: 148K
-> Moving average 4 months: 155K
-> Moving average 5 months: 164K
-> Moving average 6 months: 160K
 
- Also, as pointed out by the Fed members during the last Fed Minutes, qualitative indicators, namely the number of long-term unemployed (more than 27 weeks), the number of full-time jobs or the “underemployment rate”, are only improving slightly. Similarly, the decline in the unemployment rate is mainly explained by a fall of participation rate (lowest since Aug 1978) which is not a good thing.
 
6/ The Syrian conflict could create uncertainty to the extent that the debt ceiling has not been raised. The fact is that military action could increase  public spending above expectations and therefore could reduce the time remaining to politicians to find a compromise. Currently, according to Treasury Secretary, the deadline sould be reached by mid-October.
 
7/ During the G20, IMF noted that currently emerging economies are seen as particularly vulnerable to a tightening of US monetary policy and  recommended that policy makers be ready to handle a rise in financial instability. In this context, Fed could choose to give more time to other policy markers.
 
8/ Fed communaction: The Fed members have not yet defined criteria or thresholds which would impact the asset purchase program.
 
- Moreover, since last FOMC, almost all members (voters and non-voters) have instisted on the fact that “tapering” will be only dependent on data which were clearly weaker than expected. The last Beige Book comfirms that activity continued to expand at a modest to moderate pace during the reporting period of early July through late August.
 
- Finally, some people forget that voters are more “dovish” that non-voters and that they give less press interviews.
 
- All Fed members’ speeches concerning QE and economic activity since the last FOMC meeting (July 30-31) are available here.