Wednesday, August 21, 2013

FOMC Minutes Set Stage for Tapering
Today’s minutes of the July 30-31 FOMC meeting suggest that QE tapering is likely to begin following the next meeting on September 17-18. Here are some of the clues:

1) On the economy. Economic growth was slower during the first half of the year than many participants expected. They mostly blamed tighter fiscal policy for the slowdown. Slower growth overseas also slowed exports. Looking ahead, they “generally continued to anticipate that the growth of real GDP would pick up somewhat in the second half of 2013 and strengthen further thereafter.” They cited several reasons why this might happen, including “highly accommodative monetary policy, improving credit availability, receding effects of fiscal restraint, continued strength in housing and auto sales, and improvements in household and business balance sheets.” On the other hand (since many of them are economists), the participants are worried about “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.”

2) On the wealth effect. Participants expect that recent high readings of consumer confidence and rising household wealth will boost consumer spending. However, a few of them cautioned that the wealth effect might be weaker than in the past if consumers might not view rising equity prices as lasting and if extracting home equity is harder to do now. The participants mostly expect that housing activity will continue to improve and that home prices will continue to rise despite the rise in mortgage rates. They are counting on strong pent-up demand to keep housing going. However, they are concerned that mortgage refinancing has dropped sharply.

3) On employment. The committee is impressed with recent payroll employment gains through June. However, the minutes noted that the unemployment rate remains high and that the participation rate and the employment-to-population ratio are low. Furthermore, there are still too many people working part-time for economic reasons. In addition, “It was noted that employment growth had been stronger than would have been expected given the recent pace of output growth, reflecting weak gains in productivity.” Not mentioned was the possibility that the slow pace of GDP growth during the first half was consistent with the trend to hire more part-time workers.

4) On inflation. There was a wide range of opinions on when inflation might rise back to the FOMC’s 2% target. However, more participants expected inflation to remain below 2% for some time than expected a fast pickup:
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 and further supporting the case for highly accommodative monetary policy.
5) On bond yields. The minutes acknowledged that the financial markets were confused by the message in the FOMC’s statement following the June meeting and Fed Chairman Ben Bernanke’s subsequent press conference. Both might have “heightened financial market uncertainty about the path of monetary policy and a shift of market expectations toward less policy accommodation.” However, the participants were mostly satisfied that they had succeeded in clearing up the confusion, as various Fed officials stressed that “a highly accommodative stance of monetary policy would remain appropriate for a considerable period after purchases are completed.” In other words, the federal funds rate will remain near zero long after QE is terminated.

As a result, many participants felt that the markets now understand the game plan (whatever it is): “A number of participants mentioned that, by the end of the intermeeting period, market expectations of the future course of monetary policy, both with regard to asset purchases and with regard to the path of the federal funds rate, appeared well aligned with their own expectations.” Of course, since the end of July, bond yields have continued to rise, suggesting that the markets aren’t as aligned with their views as they thought back then.

At the July meeting, “some participants” were concerned that the rise in bond yields could slam the brakes on the economy. However, “[s]everal others” were much less worried about the backup in yields. Maybe more of them are now that yields have continued to spike higher.

6) On QE. The minutes confirmed that “almost all participants” felt “broadly comfortable” with the plan for tapering QE presented in Bernanke’s June post meeting press conference and in his July monetary policy testimony. If the economy continued to improve, with the unemployment rate heading down to 7% and the inflation rate rising back to 2% by mid-2014, then QE would be terminated by then.

7) On forward guidance. The committee also discussed what to do about its forward guidance, and decided to reaffirm that 6.5% remains the threshold for the unemployment rate. The FOMC won’t even start talking about raising the federal funds rate until the jobless rate falls to that level. However, “several participants” were willing to consider lowering this 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.”
(Based on an excerpt from YRI Morning Briefing)

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