Friday, January 10, 2014

Tempering Tapering
How will the Fed react to today’s weak payroll employment report? When the FOMC meets on January 28-29, odds are that the committee will vote to maintain the current pace of bond purchases at $75 billion, which was lowered from $85 billion at the previous meeting on December 17-18. They might have considered tapering some more if the report had been as strong as suggested by December’s ADP private payrolls survey. Now that’s less likely.

At the previous meeting, there seemed to be a difference of opinion between the members of the FOMC and the Fed’s staff on the outlook for the economy. The former were more optimistic than the latter. Indeed, according to the minutes of that meeting, the staff viewed the risks to the forecast for real GDP growth “as tilted to the downside, reflecting concerns that the extent of supply-side damage to the economy since the recession could prove greater than assumed; that the tightening in mortgage rates since last spring could exert greater restraint on the housing recovery than had been projected; that economic and financial stresses in emerging market economies and the euro area could intensify; and that, with the target federal funds rate already near its lower bound, the U.S. economy was not well positioned to weather future adverse shocks.” Recent better-than-expected economic indicators suggested that the staff was too pessimistic, but the payroll report is more consistent with their view.

The minutes also noted that further reductions in bond purchases “would be undertaken in measured steps.” That was widely viewed as implying that the Fed might taper QE by $10 billion per meeting if the economic data remained strong. In his WSJ article on the Fed’s likely reaction to the employment data, Jon Hilsenrath concluded: “Friday’s report should put to rest for the time being any notion that the Fed will reduce the bond-buying program more quickly than planned.”

The FOMC is composed of the seven members of the Board of Governors and five Reserve Bank presidents. The president of the Federal Reserve Bank of New York serves on a continuous basis; the presidents of the other Reserve Banks serve one-year terms on a rotating basis. This year, the voting presidents will be Sandra Pianalto (Cleveland), Charles Plosser (Philadelphia), Richard Fisher (Dallas), and Narayana Kocherlakota (Minneapolis). On Friday, President Barack Obama nominated Stanley Fischer as the Fed’s next vice chairman and Lael Brainard as a governor. He also nominated Governor Jerome Powell to another term.

My assessment is that not much will change under incoming Fed Chair Janet Yellen. The doves will continue to determine the course of monetary policy. However, tapering should continue, with the termination of QE likely by the end of the year. Stanley Fischer is likely to be a more pragmatic and less liberal vice chair than was Ms. Yellen. He has expressed some skepticism about providing forward guidance. However, he is likely to be a team player.

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