Today, the FOMC finally got around to initializing the “taper.” It reduced the purchase of mortgage related securities by five (5) billion dollars beginning in January 2014 and a like amount of Treasury securities. Purchases in January will drop to $35 billion of mortgage securities and $40 billion of long term Treasury securities, (a total of $75 billion) while the Fed’s balance sheet continues to grow by those amounts as principal repayments will also be re-invested and the policy of rolling over maturing Treasury securities is continued.
The Committee said that economic activity is expanding at a moderate pace and that there has been further improvement in labor market conditions. At the same time, there is no strong evidence of rising inflation or inflation expectations. Since inflation is still well below the Committee’s target of 2.0%, and unemployment at 7.0% is well above its target of 6.5%, there is no rush to raise the Federal Funds rate. In fact, based on the forecasts presented by the 17 members of the Committee, as measured inflation is well below what the Committee feels is appropriate, the Chairman indicated that the accommodative stance of monetary policy is likely to be continued well into 2015. The lengthening of forward guidance is a kind of Bernanke “Twist.”
With the Funds rate at the zero bound, the usual tool of monetary policy (interest rate changes) is inoperative and that has given rise to Fed balance sheet expansion via these asset purchases and at the same time, a policy of forward guidance to markets that the Funds rate is unlikely to rise for a considerable period. Lessening the magnitude of asset purchase—and likely further drops in asset purchases in the forthcoming year—has created a need to re-assure debt markets that a return to normal, interest rate based monetary policy is a long way off. The Chairman stressed the dependency of this forward course on continuing improvements in macroeconomic data and at the same time allowed for a reversal of the “taper” if as yet unforeseen and untoward macroeconomic data begin to show up. Thus the magnitude of the taper and its future amounts is not set in stone. It is “data dependent.” In the Chairman and the Committee’s view, monetary policy is still quite accommodative, both from the point of view of continuing to add to the Fed’s balance sheet, but more importantly by the very size of that balance sheet that weighs down interest rate rises. The market seemed to accept these statements at face value, as there was very little upward drift at the longer end of the curve. The 10-year rate moved about 5 basis points, while the equity market boomed hugely. (S&P 500 up 1.66$%, Dow 30 up 1.84% and the NASDAQ -100 up 1.16%). In effect equity traders cheered then end of the “taper uncertainty.” The vote on the Committee for these policies was nearly unanimous, with the exception of Rosengren of the Boston Fed who felt the unemployment rate was “still elevated and well below the target.”
The new Committee forecasts show improvement in the expected range of 2013 and 2014 growth rates, while the anticipated unemployment rates were lowered in each of the years stretching out to 2016. Expected inflation (as measured by the PCE index) was expected to fall slightly stabilizing at 1.7 to 2.0% in 2016. Core PCE was not expected to be much different (the lower end of the range was raised by 0.1% in 2014 (to 1.4) and again in 2016 (to 1.8). Each of the years 2013 through 2016 was lowered from the September projection.
BB’s Press Conference
As I watched his press conference, I was struck by his comfort and his mastery of the data, the policy debate and his complete ease in answering each of the questions. Bernanke is well known as a baseball fan. Today, he was definitely on his game.
The “twist” he has underscored is not written in stone and it is not a pair of handcuffs on the incoming Chairperson. Data dependency is still in play, however he noted that Janet Yellen was in concordance with the entire statement and the underlying measures that are reflected in the wording. Bernanke has one more meeting as Chairman, and if the data continue to improve (or at least not worsen), it is likely that more tapering will be voted in that meeting. What the future pace of tapering might be once Yellen assumes the Chair is speculative at this point. Furthermore, there will be new members of the Committee surely by February, probably including Stanley Fischer, the former Chairman of the Bank of Israel and Deputy Manager of the IMF. Fischer’s likely relevance is that he has reportedly commented that he is not terribly in favor of strong “forward guidance” as he finds that the predictive power of Central Banks is not sufficiently great, particularly at long intervals. What a Yellen-Fischer combination is likely to do to forward guidance and the pace of tapering will be the next uncertainty faced by equity and debt traders. Today, it was all cheering. Next year may be different
Perhaps the most interesting answer given by Bernanke in the press conference was in answer to the question of why it is with all the measures taken by the Fed that growth has not resumed its former long term tendency and even more important, that unemployment is still far in excess of recoveries in past recessions. Bernanke pointed out that first, fiscal policy has been part of the extreme headwinds, certainly over the past year and that other uncertainties such as the banking issues in Europe have not yet created the growth push of a normal recovery. He pointed out, for example, that in the prior recovery, State and Municipal employment rose about 600,000 while in this recovery, public employment was down some 400,000. A million less public jobs has made reducing the unemployment rate much more difficult. In his closing remarks, he reiterated the William Mcchesney Martin adage of the Fed being “independent within the Government,” reminding critical Congressmen that Congress writes the rules and the Fed is charged with carrying them out. Clearly, Bernanke meant to assuage some of the more vociferous advocates of “audit” and “control of the Fed” in saying that Congress certainly has the right to ask questions of the Fed and to set the ground rules for Fed targets. He did not get into the “audit the Fed” controversy but he clearly has still one more Hill to climb and surely hopes that it won’t be an ordeal