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March 20, 2013

Fed Watch: Fed Holds

Tim Duy:
Fed Holds, by Tim Duy: The two-day FOMC meeting concluded with policy unchanged, as expected. The statement itself was little changed as well. The Fed acknowledged the improved flow of data since the last meeting, noted tighter fiscal policy, and reaffirmed its view that inflation is likely to remain at or below the 2 percent target. The Fed removed a statement referring to easing global strains, presumably a reflection of the challenges in Cyprus at the moment. Asset purchases continue at their current rate.
A more interesting change can be seen in the Fed's statement regarding the future of the asset purchase program. The relative paragraph from the January statement:
The Committee will closely monitor incoming information on economic and financial developments in coming months. If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until such improvement is achieved in a context of price stability. In determining the size, pace, and composition of its asset purchases, the Committee will, as always, take appropriate account of the likely efficacy and costs of such purchases.
was changed to this (emphasis added):
The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.
The addition of the final clause appears to be a bow to policymakers who are concerned that the pace of easing might need to be curtailed in the nearer future. I assume this issue will once again be highlighted in the minutes. It appears to give the Fed room to alter the pace of purchases as the unemployment rate tends toward the 6.5 percent threshold even if, for example, jobs continue to grow in the 150k-200k range.
That said, I expect asset purchases to continue at this pace for most of this year (if not into next year). Moreover, most policymakers expect this as well. Note the relatively minimal changes to the projections:
Projections
While the expected unemployment rate was revised downward, the Fed expects it to remain unacceptably high. Moreover, the top end of the expected inflation rate was revised downward for this year. The combination of high unemployment and low inflation argue for sustained easing. Indeed, the combination could argue that policy needs to be even more accommodative. Note also that the unemployment rate is expected to exceed 6.5% through 2015, putting that year as timing of the first rate hike, And, unsurprisingly, that is the expectation of vast majority of meeting participants.
In short, with unemployment this high and inflation this low, the benefits of continued easing exceed any potential costs. And with this in mind, note that Federal Reserve Chairman Ben Bernanke, in the press conference, stated that he did not see anything unusual in current equity valuations, another indication that he believes that concerns about financial market distortions are overblown.
Bottom Line: Policy is on hold. On hold for a long time. Unless activity accelerates substantially, asset purchases will continue at the current rate through most of this year (if not until well into next year), while short-term interest rates will remain locked down near zero until 2015. Beware of reading too much into the comments of the more hawkish monetary policymakers; they still represent a minority view.

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