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FOMC meeting

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.

Fed Members Clarified Bernanke Statement

This week, eight top Fed officials spoke in an effort to clarify the statement of Fed Chairman Bernanke at the post-FOMC decision press conference on June 19th and to reassure panicky investors after the sell off on both equities and bonds’ markets.


The overall tone was to warn markets for misunderstanding the chairman’s message and to emphasize that while tapering of asset purchases will likely begin soon and will only reduces the rate of stimulus addition, interest rates were a separate issue and would remain low for a very long period.


More from Fed members’ speeches:


Fed’s Kocherlakota (dove, FOMC alternate) / Believe it will take another 2 years for US unemployment to drop to 5.5% once it has reached 6.5%. May be appropriate to keep rates near zero even after unemployment falls to 5.5%.


Fed’s Fisher (hawk, FOMC alternate) / Not in favor of ending stimulus immediately; “can’t go from wild turkey to cold turkey.” Exit strategy is still way out in the future. The word ‘exit’ does not work for the Fed now, the exit will be way out in the future.


Fed’s Lacker (hawk, FOMC non-voter) / Low inflation expected to be transitory, markets may have gotten a bit ahead of themselves with respect to tapering response; Not “anywhere near” reducing balance sheet size.


Fed’s Dudley (dove, FOMC voter) / Initial rate hikes are a long way off, could arrive well after 6.5% unemployment level is crossed; economy may diverge significantly from FOMC forecast.


Fed’s Powell (moderate, FOMC voter) / Market expectations for a 2014 rate increase are out of line with the Fed’s view, it is most likely that asset purchases will continue for some time.


Fed’s Lockhart (moderate, FOMC non-voter) / Interest rate increases are likely to come sometime in 2015.


Fed’s Stein (dove, FOMC voter) / The Fed has said nothing that suggests it has plans to change interest rates.


Fed’s Williams (dove, FOMC non-voter) / Cutting bond purchases does not change promise to keep rates low until unemployment falls to 6.5%.


The surge in bond yields that began in early May and accelerated after Bernanke’s June 19th press conference appears to have topped out for the moment after Fed members’ speeches. The yield on the US 10-year hit a nearly two-year high of 2.66% on Monday, but has backed off this level to trade as low as 2.48%.

Analysts note that other bond markets have been even more volatile. For instance the Barclays US Corporate High Yield Index briefly topped 7% early in the week – up from 5% on May 8th.

In the week ended June 26, according to FT, bruised by the first widespread losses for bondholders, investors pulled $8.6bn from US bond funds, contributing to the worst four-week streak since the depths of the financial crisis.