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FOMC Minutes

FOMC Minutes Confirm That “Tapering” Is Closer Than Expected

- Christophe Barraud

 

Last night, the FOMC published Minutes from October meeting. Even they did not provide specific insight into the timing of an initial tapering move, they suggested that (1) “tapering” will start in coming months even before an unambiguous further improvement in the outlook was apparent”, (2) Fed members considers equal cuts to MBS and Treasury Purchases, (3) Fed has yet to determine the best way to help further distinguish between tapering and tightening.

 

We could isolate some excerpts from the FOMC Minutes:

 

Participants reviewed issues specific to the Committee’s asset purchase program. They generally expected that the data would prove consistent with the Committee’s outlook for ongoing improvement in labor market conditions and would thus warrant trimming the pace of purchases in coming months. However, participants also considered scenarios under which it might, at some stage, be appropriate to begin to wind down the program before an unambiguous further improvement in the outlook was apparent. A couple of participants thought it premature to focus on this latter eventuality, observing that the purchase program had been effective and that more time was needed to assess the outlook for the labor market and inflation; moreover, international comparisons suggested that the Federal Reserve’s balance sheet retained ample capacity relative to the scale of the U.S. economy.

 
A number of participants believed that making roughly equal adjustments to purchases of Treasury securities and MBS would be appropriate and relatively straightforward to communicate to the public. However, some others indicated that they could back trimming the pace of Treasury purchases more rapidly than those of MBS, perhaps to signal an intention to support mortgage markets, and one participant thought that trimming MBS first would reduce the potential for distortions in credit allocation.

 

Participants discussed the financial market response to the Committee’s decisions at its June and September meetings and, more generally, the complexities associated with communications about the Committee’s current policy tools. A number of participants noted that recent movements in interest rates and other indicators suggested that financial markets viewed the Committee’s tools–asset purchases and forward guidance regarding the federal funds rate–as closely linked. One possible explanation for this view was an inference on the part of investors that a change in asset purchases reflected a change in the Committee’s outlook for the economy, which would be associated with adjustments in both the purchase program and the expected path of policy rates; another was a perspective that a change in asset purchases would be read as providing information about the willingness of the Committee to pursue its economic objectives with both tools.

 

Since the last FOMC meeting, several figures have showed that growth will be stronger than expected in H2 2013. Moreover, PCE inflation rebounded in Q3 and the October employment report was very strong. As a consequence, if the incoming data confirm the recent improvement and the Congressional budget committee finds a comprise concerning fiscal issues by Dec. 13, the Fed could decide to taper before the end of the year which is sooner than expected (March 2013).

 

Regarding the constitution of asset purchases, I think that people were surprised to read that the Fed could reduce both its Treasuries and MBS’ purchases in the same time. The fact is that MBS market is less liquid and impacts directly mortgage rates.

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.

FOMC Minutes: Fed will “Taper” in 2013 but not in September

FOMC published minutes of July 30-31 meeting which show that Fed officials were guarded when discussing what to do with QE purchases and decided to wait for more data. Even if they were “broadly comfortable” with Chairman Ben S. Bernanke’s plan to taper this year if the economy strengthens, with a few saying a reduction may be needed soon, several points suggest that “September” will not be appropriate.

 

A few excerpts from the Fed classified by theme:

 

1/ Growth
- A number of participants indicated, that they were somewhat less confident about a near-term pickup in economic growth than they had been in June; factors cited in this regard included recent increases in mortgage rates, higher oil prices, slow growth in key U.S. export markets, and the possibility that fiscal restraint might not lessen.
- Nonetheless, some participants felt that, as a result of recent financial market developments, overall financial market conditions had tightened significantly, importantly reflecting larger term premiums, and they expressed concern that the higher level of longer-term interest rates could be a significant factor holding back spending and economic growth.
 
2/ Employment
- The unemployment rate had declined considerably since then, and recent gains in payroll employment had been solid. However, other measures of labor utilization–including the labor force participation rate and the numbers of discouraged workers and those working part time for economic reasons–suggested more modest improvement, and other indicators of labor demand, such as rates of hiring and quits, remained low.
- While a range of views were expressed regarding the cumulative improvement in the labor market since last fall, almost all Committee members agreed that a change in the purchase program was not yet appropriate.
 
3/ Inflation
- A few participants, who felt that the recent low inflation rates were unlikely to persist or that the low PCE inflation readings might be marked up in future data revisions, suggested that, as transitory factors receded and the pace of recovery improved, inflation could be expected to return to 2 percent reasonably quickly.
- A number of others, however, viewed the low inflation readings as largely reflecting persistently deficient aggregate demand, implying that inflation could remain below 2 percent for a protracted period.
 
4/ Financial risks
- Some participants also stated that financial developments during the intermeeting period might have helped put the financial system on a more sustainable footing, insofar as those developments were associated with an unwinding of unsustainable speculative positions or an increase in term premiums from extraordinarily low level.
 
5/ QE views
- A few members emphasized the importance of being patient and evaluating additional information on the economy before deciding on any changes to the pace of asset purchases.
- In the view of the one member who dissented from the policy statement, the improvement in the labor market was an important reason for calling for a more explicit statement from the Committee that asset purchases would be reduced in the near future.
- A few others pointed to the contingent plan that had been articulated on behalf of the Committee the previous month, and suggested that it might soon be time to slow somewhat the pace of purchases as outlined in that plan.
 
6/ Forward guidance
- Finally, the potential for clarifying or strengthening the Committee’s forward guidance for the federal funds rate was discussed. In general, there was support for maintaining the current numerical thresholds in the forward guidance. A few participants expressed concern that a decision to lower the unemployment threshold could potentially lead the public to view the unemployment threshold as a policy variable that could not only be moved down but also up, thereby calling into question the credibility of the thresholds and undermining their effectiveness.
- Nonetheless, several participants were willing to contemplate lowering the unemployment threshold if additional accommodation were to become necessary or if the Committee wanted to adjust the mix of policy tools used to provide the appropriate level of accommodation.
- A number of participants also remarked on the possible usefulness of providing additional information on the Committee’s intentions regarding adjustments to the federal funds rate after the 6-1/2 percent unemployment rate threshold was reached, in order to strengthen or clarify the Committee’s forward guidance.
- One participant suggested that the Committee could announce an additional, lower set of thresholds for inflation and unemployment; another indicated that the Committee could provide guidance stating that it would not raise its target for the federal funds rate if the inflation rate was expected to run below a given level at a specific horizon.

 

My view
 
- Firstly, it’s clear that Fed members will start “tapering” in 2013 to the extent that a few said “it might soon be time to slow somewhat the pace of purchases as outlined in that plan”.
Moreover, it’s clear that financial risks are increasing as “unsustainable speculative positions” have grown.
 
- Yet, contrary to consensus, I still believe that “tapering” will not start in September because of several factors:
1/ Minutes show that Fed members were a bit more pessimistic about near-term economic performance and they fear the debate on public finances which should take place until the end of September.
2/ As a consequence, they decided to wait for more data. However, the July employment report which was released a few days after this FOMC meeting was disappointing (although the unemployment rate declined to 7.4%).
3/ Fed officials appear to be unconvinced about labor market improvements.
4/ There were mixed views on current low inflation and it’s clear that damage that could come from a rate backup.
5/ Even if some participants (Fisher or Lacker) believe that “tapering” should start in September, they will not vote at the next FOMC meeting.

 
- Finally, as WSJ’s Hilsenrath noted,  Minutes suggest that changes in interest rate guidance are on the table.