Wednesday, June 19, 2013

The Fed’s Threshold for Ending QE
Some of the country’s smartest macroeconomists predicted today that “the downside risks to the outlook for the economy and the labor market… [have]… diminished since the fall.” So why did the S&P 500 drop 1.4% today? This upbeat economic assessment appeared in today’s FOMC statement. The Fed's relatively sanguine risk assessment is a new development. The previous statement dated May 1 noted: “The Committee continues to see downside risks to the economic outlook.”
The latest statement repeated the FOMC’s previous promise to keep the federal funds rate near zero as long as the unemployment rate remains above 6.5%. Also repeated was the promise to maintain the current pace of QE “until the outlook for the labor market has improved substantially.” Nevertheless, there were some new insights today on the likely course of monetary policy that clearly upset the markets:
(1) NZIRP & the 6.5% unemployment rate threshold. The FOMC’s latest table of the “central tendency” of the members’ economic projections now shows the unemployment rate falling to 6.5%-6.8% next year, down from their March forecast of 6.7%-7.0%. The 2015 jobless rate forecast was lowered from March’s range of 6.0%-6.5% to 5.8%-6.2%. In other words, the 6.5% threshold for this rate is now expected in 2014 rather than 2015. No wonder that bond yields spiked.

In his press conference, however, Chairman Ben Bernanke stressed that the FOMC won’t automatically begin to raise the federal funds rate when the unemployment rate falls to 6.5%. Instead, the committee will commence discussions to do so.

(2) QE & the 7.0% unemployment rate threshold. In his press conference, Bernanke also specified, for the first time, that 7% is the jobless rate threshold that would mark a substantial improvement in the labor market. The Fed will start reducing its bond purchases later this year if this rate continues to fall toward 7% by the middle of next year, as anticipated by most of the members of the FOMC, according to Bernanke.

(Based on an excerpt from YRI Morning Briefing.)

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