The Fed surprised the markets by keeping its asset purchase programme unchanged at its meeting of 17-18 September. There seem to have been two main factors behind the decision not to reduce monetary stimulus.…
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1) fiscal consolidation, which is still under way, and 2) the “tightening of financial conditions observed in recent months”. The outcome of the FOMC came as a surprise, considering the communication campaign that started in May, aimed at preparing the scene for a tapering of purchases “later this year” if the scenario evolved as expected. The Fed’s communication was compatible with a likely reduction in the pace of asset purchases until a few weeks ago, and since then there have been no significant developments on the macroeconomic front. Therefore, the central bank’s about-turn over the expectations that it itself had widely and chorally fuelled, is particularly surprising.
A more reasonable explanation than those contained in the statement may lie in uncertainties tied to “autumn politics”, on two fronts. On the one hand, the appointment of candidates to chair the Fed has become an element of controversy between the White House and Congress, and the process is now difficult; on the other, the end of the continuing resolution funding the Treasury budget and the debt ceiling are approaching, without a strategy in place to solve the conflict between Republicans and Democrats, which reopens the possibility of a government shutdown (albeit a remote one). Whatever the reason behind the decision to leave conditions unchanged at this latest meeting, the Fed has undoubtedly lost credibility, and will have its work cut out for it once it will start preparing the markets (again) for a tapering of purchases: the premium for uncertainty will increase, after the initial euphoria.
The statement contains no indications of a deviation of the economic scenario, although it does say that mortgage rates have risen “further”, whereas fiscal policy is holding back growth. While confirming its forecast that the moderate recovery will continue, the Fed sates that “the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labour market”. Therefore, taking into account fiscal consolidation, the Committee will await further evidence before slowing the pace of purchases.
During the press conference, Bernanke avoided any direct reference to unemployment rate levels which could prompt an unwinding of the asset purchase program, stating in fact that there is no “magic number” to refer to. In essence, communication has become much hazier on the future of asset purchases, although Bernanke once again stressed the separation between the size of the balance sheet and an interest rate hike. As expected, forecast growth and unemployment at the end of 2013 were revised downwards slightly. The new projections for 2016 point to growth and unemployment values in line with long-term averages, and to an inflation rate of close to 2%. As regards interest rates, a large majority of participants continue to expect the first hike in 2015, and the rate path to prove very moderate: the forecast median rate is 1% at end-2015, and 2% at end-2016. Despite the revision of 2013 forecasts, the expected path of interest rates has not changed much.
In conclusion, the FOMC’s surprise decision does not signal a different view on the economic outlook. The improvement is still under way: Bernanke stressed the progress recorded on the labour market, cooling concerns that the drop in the unemployment rate may be due principally to a decline in the participation rate. If the no-action decision taken in September is tied to uncertainties over political developments, we expect that once fiscal obstacles due in October will have been overcome, and Bernanke’s successor appointed, the Fed will resume the process of preparing the markets for a tapering of purchases. How the market will react remains to beseen, given the Fed’s loss of credibility in terms of communication. For the time being, the markets are benefiting from the effects of a true surprise, brought about by a central bank that until a few days ago claimed that optimal monetary policy management must aim to keep surprises to a minimum! For the time being, we have pushed back to December the expected date of an initial tapering of purchases.
Source: BONDWorld – Intesa Sanpaolo – Research Department
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