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Bullard Does Not Seem Ready to “Taper”

On Friday, after the publication of the July Employment report, Federal Reserve Bank of St. Louis President James Bullard, said the Fed should wait for evidence the labor market and economy are strengthening before tapering purchases. Moreover, he estimated that the Federal Reserve Committee should not remove accommodation in a context where inflation remains particularly low.

 

More from Bloomberg:

 

“The committee needs to see more data on macroeconomic performance for the second half of 2013 before making a judgment on this matter.”
 
“The committee would not normally remove policy accommodation in an environment where inflation is below target and is projected to remain there.”

 

Bullard’s analysis is coherent to the extent that 3 (GDP, PCE inflation, PCE Core Inflation) of 4 the main economic indicators followed by the Federal Reserve are far away from the targets set at the June meeting.

 

More from CalculatedRisk:

 

With the exception of the unemployment rate, it would be a stretch to say the incoming data has been “broadly inconsistent” with the June FOMC projections.

 

I’ll wait for the next feedback from other Fed members, however, in my opinion, there is no doubt that “tapering” will not start at the next Fed meeting (September 17-18).
 

What Fed Members Said About QE and What Does it Mean?

In May, Fed members expressed a range of views on the asset purchases program. Philadelphia Fed President Charles Plosser called for shrinking purchases at the Fed’s next meeting; San Francisco’s John Williams favored a reduction perhaps as early as this summer but did not exclude the possibility of increasing pace of QE purchases following any tapering. By contrast, Boston’s Eric Rosengren said low inflation and high unemployment suggest there may be a need for even more stimulus, not less. Finally, Fed Chairman Bernanke has made it clear that it is prepared to either increase or reduce the pace of asset purchases depending on economic conditions.

 

Here are the main abstracts of Fed members’ speech and we can distinguish those which support a continuation of the asset purchases programm and those which are cons:

 

I/ Pros

 

On May 23 – Fed’s Williams (dove, FOMC non-voter): Reiterates more signs of improvement are needed before purchases can be slowed.
- Could increase pace of QE purchases following any tapering, will not be on auto pilot after tapering has begun.

 

On May 23 – Fed’s Bullard (moderate, FOMC voter): Bond buying should respond to economic data – comments from London.
- QE still most effective easing tool when rates are near zero.
- Unconventional measures should keep inflation expectations near target.

 

On May 22 – Fed Chairman Bernanke (dove, FOMC voter): FOMC has made it clear that it is prepared to either increase or reduce the pace of asset purchases depending on economic conditions – Congressional testimony on Economic Outlook
- Says a premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further.
- High rates of unemployment and underemployment are extraordinarily costly.
- Fiscal policy continues to exert a substantial drag on the US economy. Monetary policy cannot offset the drag on the economy from fiscal policy.
- Fed policy has helped to offset deflationary pressures and kept inflation from falling even further under the 2% target.
- Longer-term inflation expectations are still stable, inflation to be at or below 2% for the next few years.
- Loose monetary policy is providing significant benefits.

 

On May 22 – Fed’s Dudley (dove, FOMC voter): policy makers will know in three to four months whether the economy is healthy enough to overcome federal budget cuts and allow the central bank to begin reducing record stimulus – comments to Bloomberg TV.
- Says QE tapering possible by Autumn if economy improves
- Says Fed hasn’t decided yet on tapering timing, steps
- Says Fed wants to make sure markets do not overreact to tapering

 

On May 21 – Fed’s Bullard (moderate, FOMC voter): Inflation is low, cannot see a good case for tapering the bond purchases until low inflation is corrected – comments to reporters
- Adjustable bond buying is the best fit for QE, especially with rates near zero.
- No need to reduce volume of bond buying in the near term.

 
On May 21 – Fed’s Dudley (dove, FOMC voter): Current Fed exit strategy is stale and requires revision, too soon to say when the Fed will adjust the pace of bond buying.
- Fed must be willing to fight any threat of deflation, considerable weight needs to be put on risk of deflation.
- Expects to see enough labor market improvement to justify lower asset purchases, but final decision will be based on how well the economy deals with its fiscal drag.
- Market could over-react to first adjustment in the pace of asset purchases.
- Fed might not sell off MBS when it reduces its balance sheet in the future. May hold assets to maturity.

 
On May 20 – Fed’s Evans (dove, FOMC voter): Fed could continue buying bonds at the current rate through the fall or it could abruptly end the buying program if the labor market improvement looks to continue.
- Would be open-minded about discussing possible adjustments to the pace of bond buying at the next several FOMC meetings.
- It is still too early to get overly uncomfortable about inflation that is too low, however a few more months of low inflation might be different.
- Monthly payroll gains of 200K+ are still the criterion for an improved labor market.
- Sympathetic to Kocherlakota’s argument that the Fed has not provided enough accommodation, but not clear if Fed should consider the idea of adjusting its thresholds.
- Fed policies have been working, need a little bit more time to determine whether the labor market has improved substantially.

 
On May 17 – Fed’s Kocherlakota (dove, FOMC alternate): maintained Friday his support for the Fed’s aggressive measures to spur faster economic growth.
- warns that the costs of tightening monetary policy now would significantly outweigh any benefits for financial stability.
- Says Fed has not lowered real interest rates enough, tighter monetary policy would not benefit financial stability
- This has led him to the conclusion that “financial stability considerations provide little support for reducing accommodation at this time.”

 
On May 16 – Fed’s Rosengren (dove, FOMC voter): Highly accommodative monetary policies are appropriate; low inflation boosts risk of a negative shock that could undermine stable inflation expectations.
- Highly accommodative policies are still needed despite the stronger economy and improvements in the labor market.
- Improvements in the economy and labor markets are due in part to accommodative monetary policy.
- There is a case to be made for even more aggressive monetary policies.

 
II/ Cons

 

On May 22 – Fed’s Fisher (hawk, non-voter on FOMC): Inflation is not an issue at the moment; accommodative policy right now is pointless given current fiscal policy.
- Fed could reduce the rate of MBS purchases under QE.
- Not alone in thinking that housing has improved enough to scale back bond purchases.
- Fed has ample scope to reduce asset purchases and slow pace of MBS purchases.

 

On May 20 – Fed’s Fisher (hawk, FOMC non-voter): Unclear whether bond buying has worked for the US economy.
- Would have started tapering last week.
- Would like to see a scaling back of MBS purchases when it is time, not a full stop as that would be too violent for the markets.

 

On May 16 – Fed’s Fisher (hawk, FOMC non-voter): Fed should reduce MBS purchases and end them by year end – comments from NABE Industry Conference in Houston.
- Sees MBS purchases as potentially disruptive.
- Economy appears to be strong enough to encourage job growth in the near term.

 
On May 16 – Fed’s Williams (dove, FOMC non-voter): reiterates Fed may be able to taper bond buying as early as this summer.
- Job market has improved a great deal since the Fed initiated QE3, all signs point toward further progress with jobs.
- If everything goes as hoped, Fed could end asset purchases by sometime in late 2013.

 

On May 14 – Fed’s Plosser (hawk, FOMC non-voter): Reiterates would be in favor of reducing QE; Fed should taper QE as soon as June 18-19th meeting- comments from Stockholm.
- Slowing inflation is not a concern for policy; sees level as moderate in near-term

 

III/ My view

 
Before these speech, my first guess was that Fed could start tapering its bond-buying program in September, nevertheless, since almost all FOMC voters seem ready to extend it until economic conditions improve substantially, I believe that December is more likely because:

 

1/ Currently, the US recovery is still modest and vulnerable to global environment especially China and Eurozone,

2/ US fiscal policy should be a drag at least until Q3 2013.

3/ The debt ceiling problem is not addressed by politics and could also affect negatively consumer and companies’ confidence in Q3 2013.

4/ Employment is still high at 7.5% and has decreased mainly because of a drop of participation rate and not a real improvement on the labor market.

5/ In April, inflation was at the lowest since November 2010 at 1.1% YoY and should remain contained in the medium term.

 

Plosser Said that Fed Should Taper QE as soon as June 18-19 Meeting

In a speech in Stockholm, Philadelphia Fed President Charles Plosser, known for his conservative views, said Tuesday that Fed could taper its asset purchases program as soon as next month due to the improvement on the labor market situation:
 

“I believe that labour market conditions warrant scaling back the pace of purchases as soon as our next meeting”

 
Note that next meeting refers to a gathering of the Federal Open Market Committee (FOMC) on June 18-19. He justified his approach warning on Fed credibility:
 

“Were the FOMC to refrain from reducing the pace of its purchases in the face of this evidence of improving labor market conditions, it would undermine the credibility of the Committee’s statement that the pace of purchases will respond to economic conditions”

 
He also added that Fed does not need to take into account financial markets’ reaction:
 

“If we become reluctant to dial back on purchases over concerns of disappointing or surprising markets, then we will find ourselves in a very difficult position going forward”

Finally, even if he talked about inflationary risk, the most serious argument was that:
 

“Officials should also rethink investment strategy; might be more prudent to invest in shorter-term assets instead of reinvesting maturing and prepaid assets into longer-term ones”

 
I believe that Plosser view is isolated and Fed members will wait for at least the September meeting before tapering QE. Even if the situation on the labor market has improved since the beginning of the year, a lot of uncertainties on the conomic situation remain such as the impact on sequestration in Q2 and Q3 and the debate on the debt ceiling. Moreover, note that Plosser will not be one of the 12 people voting on the Fed’s decisions until 2014.

When Should the Fed Taper its Asset Purchases Program?

This question became the focus of investors after the Wall Street Journal unveiled on May 11 that Fed have wapped out a strategy for winding down the $85 billion-a-month bond-buying program. The article notes that:
 

“Officials say they plan to reduce the amount of bonds they buy in careful and potentially halting steps, varying their purchases as their confidence about the job market and inflation evolves. The timing on when to start is still being debated.”

In my opinion, Fed is likely to start tapering its asset purchases program after the meeting of September 17-18 for different reasons:
 
1/ The six-month moving average of nonfarm payrolls reached 208 K in April, a level above the target of 200 K set by several Fed members. Moreover, on May 3, intial claims reached its lowest level since January 2008 underlining the recent improvement on the labor market.
 
2/ Nevertheless, I can’t imagine that Fed will start reducing its asset purchases after June meeting without clarifying its strategy and avoiding an overreaction from the financial markets. Furthermore, inflation pressures will remain low in the medium term as wages’ increase are moderated. This situation will offer room for Fed to take its time.
 
3/ The July meeting is also unlikely to the extent that we saw in the previous article that politics should probably  find an agreement on the debt ceiling at the same time. Therefore, it will be difficult for Fed to anticipate the result of the negociations. Besides, this meeting will not be followed by a press conference.
 
4/ Therefore, the next meeting scheduled for September 17-18 should be the best moment as I expect the macro environment to be better with the beginning of a recovery in Eurozone and a moderate growth in US. As a consequence, the situation on the labor market will keep on improving as companies’ expectations will be higher. Note that this meeting will be followed by a press conference and will be used by Bernanke to explain its choice.