Tuesday, June 17, 2014

FOMC Report June 17-18, 2014




Expectation: The June FOMC statement will remain largely unchanged from April though it will acknowledge slightly improved current growth prospects.  The ‘policy-path’ of tapering will continue with another $10 billion cut.  Work will continue but no firm exit strategy will be announced until the July FOMC meeting.  In the SEP, 2014 yearly growth expectations will be lowered. In an effort to learn more than the Fed is willing and able to divulge now, a reporter may move beyond the line of respectful inquiry.  Chair Yellen will be unfazed and will reiterate earlier offered guidance.  This is not a meeting that will shake things up.    

Two separate topics that currently rate high on the ‘go-to’ reading lists of market savvy are low volatility and Fed exit strategy.  Questions surround both and while proper questioning often produces useful answers, the transition from unknown to known, for the purposes of our discussion here, often involves strong market movement. 

Low volatility and decreased trading activity are evidenced across the spectrum of asset classes from bonds to stocks and from commodities to metals.  Low volatility along with unanswered questions is not really a steady state and we can expect that either low volatility will not persist or the answers found will have already been largely discounted. 

It has been years since the Fed last outlined an exit strategy from extraordinary accommodation.  It’s time for a revamp now, especially as consensus forecast places the policy rate lift-off date about a year away.  This of course is not to say that the policy rate, whether that is the heretofore standard fed funds or a newer possibility IOER or ON RRP, will be used in the first step in the transition from extraordinary accommodation to ‘normal’.   Another possible first step (or next step if you argue that tapering was the first step) would be for a quitting of the reinvestment of principal and interest in the SOMA portfolio.   In any event, we might expect this quandary being wrestled out in the market place would engender higher levels of volatility.  Policy maker’s comments should provide leverage to one side or the other in the argument thus creating more trade and greater volatility.  This has not been the case.   

One reason for lower volatility may simply be that there has been fewer Federal Reserve Board Governors’ with correspondingly fewer public comments.  The argument being that fewer conflicting comments invite a steadier market.  It is doubtful however that fewer Fed Governors’ are reason enough for punk trade and low volatility.  Greater weight might be afforded comments from fewer Governors’ instead of those messages being diluted by a fuller compliment of the Board. 

There is widespread expectation for the Fed Summary of Economic Projections (SEP) to show a still lower forecast for 2014 real GDP from the 2.8-3.0% projected in March.  Less certain but possible is a further lowering of the longer-run ‘equilibrium’ growth rate projection which, as written about in my March FOMC Report, has steadily declined since November 2011 from 2.5-2.7% central tendency to 2.2-2.3% in March. 

There is room for some disparity between the message as appears in the context of the FOMC statement and the apparent message from the dots in the SEP.  Stronger language in the FOMC statement related to brighter growth prospects and inflation that is coming more in line with Fed target may seem at odds with the continued low and possibly even lower marks for longer-run growth and equilibrium policy rates. 

Lower long-term growth expectations help to keep Treasury bond yields low but they can also have an impact on expectations for immediate prospect.  Where recoveries from recessionary periods generally experience growth above the longer-term trend, present expectation for depressed longer-run growth potential has a risk of stifling current growth.  Already, growth since recession end in June ’09 has only averaged 2.1%.   

If the Fed had a desire to mislead the public in an effort to bring long-rates lower, there is scarcely a better approach than to adjust lower public expectations for longer-run growth.  The Fed has helped reduce expectations for longer run growth by consistently missing their more optimistic nearer-period forecasts for growth over the last 4 years and by steadily lowering the SEP longer-run forecast over the last 2.5 years.  Endearing though arguably indicating ineptitude, neither the repeated annual growth forecast overshoot or the steady decline in long-run base growth potential forecast have been faked.

Chair Yellen shares an interest in painting a picture of longer-run prospects as accurately as possible as indicated in her stated and practiced principle.  However, she is also willing to act as a cheerleader as shown in efforts toward incorporating a wider interpretation of unemployment.  As such, she might want to tweak the FOMC statement description of current or immediate economic prospects slightly elevated relative to economists’ consensus in part as an effort to thwart a negative pull from a reduced longer-run GDP forecast in SEP. 


Volatility

Those who would assume that current low levels of volatility are simply attributable to dangerous levels of complacency may be missing an important consideration.  Central Banks have had a strong impact on the current level of volatility and this situation should be expected to persist for some time.  Economic agents have come to expect central bank intervention, transparency and guidance.  In general the message from central banks, the Fed in particular, has been that rates should be expected to remain low for some time.  The Fed has implied that even if economic conditions do not necessarily seem (by historic standards) to justify low policy rates, longer standing headwinds may warrant low policy rates to persist for a time.   

A greater influence on volatility than a message for persistent low rates is a belief that a decent chunk of the central bank policy rate timeline is knowable.  Different levels of confidence about the likely path for policy rates attend different periods of policy transition.  Historically, a transition from a neutral policy stance to a restrictive one would be expected to draw the greatest level of policy uncertainty.  More recently, this transition has been smoothed.  Incremental changes in policy have become the norm and concerns are much lower for more abrupt or hurried tightening.  Until the Fed gets a better handle on how to communicate during a restrictive (or removal of accommodation) policy initiative, the greatest risk for unwanted volatility will come toward the end of a tightening regime or when the Fed finishes raising rates.     

A low level of confidence for the Feds ability to determine the appropriate path for rates accompanied the height of the financial crisis.  While it was expected the Fed would react aggressively and bring policy rates lower, it was not apparent at the time either inside or outside of the Fed just how low rates might need to go and for how long would they need to stay there in order to arrest the deteriorating condition.  During such times, volatility and term premium remain high.  Later, after the recession ebbed and the extent of the damage appeared measurable, a greater confidence emerged in an ability to predict a longer period of the Fed policy rate timeline.  That greater confidence was followed by generally lower levels of volatility and term premium.   

However, we would be wrong to assume that lower levels of volatility and pressured term premiums necessarily coincide with low or declining policy rates.  Low volatility and term premium most certainly can come about during periods of rising policy rates.  Consider the period mid-’04 to mid-’06 when the Fed was struggling at lower levels along the communication learning curve.  At that time the Fed moved policy rates gradually higher in an entirely predictable fashion.  The VIX and MOVE indexes fell steadily during that period as economic agents seized upon the risk-friendly characteristics of the known policy-path.  Conversely, as the Fed lowered policy rates between ‘01 and ‘03, these indexes generally rose as economic agents were less confident that a lengthy policy-path for rates could be discerned.  

Again, possibly the biggest reason for increasing volatility in the Fed ‘easing’ period of ’01-’03 and the decreasing volatility in the ‘tightening’ period of ’04-’06 was due to the level of confidence economic agents had in their understanding of the Fed policy rate path.  In the ’04-’06 period economic agents reached great levels of confidence that the path for rates was known.  Confidence in a longer chunk of policy timeline, when policy initiative is an influential determinant of growth can clearly weigh on volatility and term premium.    

Currently economic agents have a high level of confidence that policy rates stretching far out the timeline are known.  As much as guidance from the Fed has helped to support this conviction, the economic and inflationary backdrop is also consistent with only modest improvement over the coming year almost irrespective of what the Fed might do.  Even though the Fed may move forward or backward slightly the expected timing of the policy rate lift-off there is still confidence that a post-lift-off glide path will be rather shallow.  It is not low rates or even the path for rates that impacts volatility as much as it is the expectation for variability about the path.  The Fed is expected to follow a well articulated script in the transition from aggressively accommodative to lesser levels of accommodation.  By providing believable likely future values for policy rates as well as the disposition of the SOMA portfolio, the Fed will for a time help to keep volatility low. 

However, and this is where I expect some to have difficulty following, if the Fed provides enough visibility in the form of usable transparency then volatility and term premiums should be expected to remain low and the appetite for taking risk will grow even as the Fed raises policy rates. 

The Fed may have shown some movement up the communication learning curve in the most recent policy shift toward tapering.   The Fed has learned to provide useful transparency in the form of a ‘policy-path’ description for the process of tapering of securities purchases.  Prior to the discrete and regular reduction in purchase amounts clearly articulated in the December FOMC statement and followed-up in action since, there was some heightened uncertainty concerning the process by which the Fed would step away from that form of accommodation.  By providing useful transparency in the form of measurable changes to expect in asset purchases and portfolio holdings through stages and time, the Fed helped to lower market volatility which in turn pressured term premiums and nominal rates lower.  The unknown Mr. Bernanke had awakened in the ‘taper-tantrum’ of mid-’13 had become a known policy-path, lending visibility and economic support despite lower levels of actual QE accommodation.

The Fed has become increasingly aware of the importance of communication and more adapt at affecting economic agent activities through the use of guidance.    It should be expected that the Fed’s application of guidance will be generous and widely encompassing in its use in tandem with each of its policy tools in the period of transition from greater to lesser levels of accommodation.  This has clearly been the case already with the tapering program.

Friday, April 25, 2014

FOMC Report April 29-30, 2014



Views at the Federal Reserve about the impact from severe winter weather on economic growth in Q1 2014 seem to change with the wind.  Upon the emergence of weaker economic data following harsh weather constraints, Fed officials were quick to recognize the negative impact from weather.  In the ‘Beige Book’ leading to the March FOMC meeting, reports of economic progress were upbeat; ‘Reports from most of the twelve Federal Reserve Districts indicated that economic conditions continued to expand from January to early February.’  However, where instances of slower growth were reported, weather was cited as causal; ‘New York and Philadelphia experienced a slight decline in activity, which was mostly attributed to the unusually severe weather experienced in those regions.’

By the time the Fed had met a few weeks later for the March FOMC meeting, staff economists had seemingly tired of the notion that weather was a primary contributor to weaker economic growth; ‘The information reviewed for the March 18-19 meeting indicated that economic growth slowed early this year, likely only in part because of the temporary effects of the unusually cold and snowy winter weather.’  By using the qualifier ‘only in part’ the Fed Staff indicated a growing concern that underlying conditions had deteriorated.

Finally, on April 16th Chair Yellen addressed the Economics Club of New York to discuss ‘Monetary Policy and the Economic Recovery’ noting; ‘The FOMC's current outlook for continued, moderate growth is little changed from last fall. In recent months, some indicators have been notably weak, requiring us to judge whether the data are signaling a material change in the outlook. The unusually harsh winter weather in much of the nation has complicated this judgment, but my FOMC colleagues and I generally believe that a significant part of the recent softness was weather related.’

The Fed has come full circle on their view of weather impact on growth over the last months, accepting now that it has been ‘significant’.  When they meet on April 29-30, the Fed will have the benefit of additional generally stronger economic data since the Beige Book was prepared at the Federal Reserve Bank of Richmond and based on information collected before April 7, 2014.  Employment data has shown some improvement as has retail sales, confidence, industrial production and capacity utilization, leading indicators and most recently durable goods.  Additionally, inflation data was finally slightly higher than expected in March CPI and PPI reports.  Regional Fed banks indexes reporting on manufacturing and general conditions improved in Philadelphia, Chicago, Richmond and Kansas, but was reported softer early in the period by New York (Empire State). 

Despite generally improved economic data the Fed is expected to follow earlier articulated guidance concerning its purchase plans; ‘will likely reduce the pace of asset purchases in further measured steps at future meetings.’  The level of securities purchased on a monthly basis will thus likely be reduced by $10B to $45B starting in May, a fourth similar reduction.   We should also expect no change to the qualitative guidance on the policy rate.   

Chair Yellen provided a soft reference or definition for ‘considerable time’, as in; ‘that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.’  While Yellen suggested at the March FOMC post-meeting Q&A that ‘considerable’ might be roughly 6 months, we know to use this only as a rough guide and only if growth, employment, inflation and financial market conditions are consistent with projections.   

The Fed has been using some form of general period, date specific or threshold conditional policy rate guidance since the December 16, 2008 FOMC meeting where they indicated; ‘The Committee continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.’ 

Since then, the Fed had used the guidance language ‘extended period’ to describe the likely time policy rates would be held at extremely accommodative levels until it moved to date specific language in August 2011; ‘are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.’

After extending that reference date to ‘late 2014’ in at the January 2012 FOMC meeting and then to ‘mid-2015’ in September of 2012, the Fed switched over to ‘Evan’s Rule’ - threshold guidance in December 2012, holding that language for a little over a year until the March 2014 meeting. 

The Fed is now using a softer ‘considerable time’ reference as it relates only to the period following the completion of the asset purchase program largely expected to end in October this year.  Of course, inflation needs to be found moving toward the 2% target before the Fed will commit to removing accommodation, but we find it curious that the Fed had removed from its March 2014 FOMC statement the necessity for stronger growth as specific requirement before reducing accommodation. 

The March 2014 FOMC Statement notes; ‘To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate.’  However, since December of 2012, this particular statement had always concluded with the reference; ‘that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.’  Even before the December 2012 FOMC meeting statement referenced the purchase program, the September and October of 2012 statements referenced a period beyond recovered economic strength; ‘that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.’

Later in the March ‘14 FOMC statement the Fed did mention a post-purchase period for continued highly accommodative monetary policy.  However, they dropped the reference to growth and added only reference to hoped-for improved inflation conditions; ‘The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.’  By indicating that the highly accommodative stance is appropriate ‘especially if’ projected inflation continues to run below…, the inflation condition can be read as an ideal state and not particularly a requirement before the Fed can decide to reduce accommodation.

For a very long time, the Fed has indicated that the highly accommodative policy stance should be expected to continue well beyond the time the economic recovery strengthens.  This has been removed in the March Statement.  It may be assumed, but it is not stated and it’s absence could be considered as a step toward removing barriers to lowering levels of accommodation.  The statement as it has been changed to now references policy appropriateness in the present and has thus reduced forward guidance.  Intended or not, this is how we should read that change.  Below find the aforementioned statement from present through the September 2012 meeting:    

Mar ’14 FOMC; ‘To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate.’

Jan ’14 FOMC; ‘To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.’

Dec ’13 FOMC; ‘To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.’

Oct ’13 FOMC; ‘To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. ‘

Sep ’13 FOMC; ‘To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.’

July ’13 FOMC; ‘To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.’

Jun ’13 FOMC; ‘To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.’

May ’13 FOMC; ‘To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.’

Mar ’13 FOMC; ‘To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.’

Jan ’13 FOMC; ‘To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.’

Dec ’12 FOMC; ‘To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.’

Oct 12’ FOMC; ‘To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.’

Sep ’12 FOMC; ‘To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.’  




Tuesday, March 18, 2014

FOMC Report March 18-19, 2014




The latest challenge for the Fed just got a little easier.  The unemployment rate that had been declining rapidly toward the ‘Evan’s Rule’ threshold guidance level of 6.5% eased back from 6.6% to 6.7% at the release of the February employment report earlier this month.  As the unemployment rate moved more quickly than expected toward that threshold over the last months, Fed officials made clear it was not a trigger and that other variables were being considered as a guide to when monetary policy would become less accommodative.  However, the guidance provided by that 6.5% unemployment threshold has been lost and there is little reason to continue its use.  The Fed is interested in advancing an alternative guidance that will offer support for economic progress by strongly discourage economic agents from pricing too-soon a lift-off for the fed funds policy rate. 

The Fed will in all likelihood simply drop the reference to the 6.5% unemployment rate, otherwise leaving much of the same message as before.  They could provide additional insight as to particular economic and financial measures considered, but they would not want to get too bogged down with specifics. Instead, simply being able to point toward a varied collection of economic and financial market performance measures and further being able to note those measures are not yet at levels where the Fed would consider removing accommodation could be a powerful message.  Such language could be used until just before the Fed chooses to lift policy rates.  

Few if any believe the Fed has any intention of raising policy rates before the tapering of asset purchases is completed late in the third quarter of 2014.  Fed statements have led most of the more hawkish Fed watchers to believe that the Fed would not raise fed funds policy rates for a minimum of three to six month following the completion of asset purchases.  Still, the Fed would like to have the market price that event further out in the future in order to continue to promote stable and low long-term Treasury yields. 

Efforts to promote expectations for a more distant lift-off date using the FOMC statement change that drops the 6.5% unemployment threshold guidance and replaces with qualitative guidance can be further supplemented by reference to the Summary of Economic Projections (SEP).  Some have argued that SEP values be used within the context of the FOMC statement to provide rules as to when the Fed should be expected to change policy.  Such use of SEP information not recommended as it may raise creditability concerns.  However, Fed Chair Yellen could discuss in the post-meeting report and Q&A the value of relying on such projections to recognize FOMC participant’s understanding of future values for policy rates and other economic variables. 

Expectation for longer-run real GDP and fed funds policy rates add insight into future long-term Treasury yields.  There has been a steady decline in the Fed’s (SEP) forecast for longer-run real GDP.  In January 2009 as the Fed moved to provide more formal quarterly updates for economic variables in the form of the SEP, Fed participants provided a central tendency forecast for loner-run real GDP of 2.5 to 2.7%.  This longer-run central tendency forecast was increased to 2.5-2.8% in November 2009 and remained at that level until November 2011 when it was again reduced to 2.5-2.7%.  Central tendency expectation for real GDP has steadily declined since.  In December the upper bound of the 2.2% to 2.4% range was below the lower bound (2.5%) from two years earlier. 

Clearly expectations for longer-run growth have been scaled back.  So too have expectations for longer-run ‘appropriate’ fed funds policy rate.   Starting in January 2012, the Fed began providing quarterly updates in the SEP for year-end value for fed funds policy rates expected over the next three year, as well as the expected longer-run policy rate.  The average of the participant’s rate projections has steadily declined from a starting value of 4.21% in January 2012 to 3.88% at the most recent December 2013 update. 

*Missing Chart of Longer-Run Policy Rate Forecast

The SEP has additionally provided information about the expected path for fed funds policy rates over the coming three years.  Since it has been providing such data, the participant’s expectations for the year-end value for policy rates in coming years has consistently been marked lower.  We should expect the upcoming SEP that accompanies the March 2014 FOMC meeting to show still lower expected rates in future years.  At least one of the two participants who in December had higher rate forecast for 2014 is expected to move that expectation to 2015.  Additionally, one or more participants may also move from 2015 to 2016.  The chart below shows the average year-end rate forecasted by Fed participants at the last 4 quarterly updates for SEP. 

We should expect to hear additional references to the declining trend of expected year-ending and longer-run fed funds policy rates over the coming months as it will help to support the Fed’s goal in limiting the increase in long-term Treasury rates as the Fed completes its purchase plans.  It may be the cleanest form of support for policy intent.  


Missing Chart of Year-Ending Policy Rate Forecast  
 
On Weaker Data and Tapering

The Fed’s Beige Book made clear that Fed officials had difficulty reconciling economic progress as a result of challenging weather conditions.  The report made reference to weather 25 times within the summary alone.  Still, there are some who believe some more fundamental slowing of the economy is evidenced in the data over the past months.  The Fed however is not prepared to react hastily, but instead should be expected to continue on its present course of tapering.     
Tapering of securities purchases has been moving along smoothly and we are left to expect the Fed will continue to reduce the level of monthly purchases by a ‘measured step’ reduction of $10 billion per FOMC meeting.  Fed officials have made repeated remarks about there being a ‘high bar’ for changing that pace.  You are invited to review my last FOMC report for a more detailed discussion of the ‘policy-path’ implications of tapering.  We might note here however that the main difference between the mid-’13 declaration of tapering intent and the December ’13 FOMC implementation of that intent was the stated path for tapering with strong implication for the level increment.  In the absence of that ‘policy-path’ expression, the mid-’13 discussion of tapering found only sellers of Treasuries and a jump in term premium.   

*if you would like a pdf copy that would include the charts, contact me at edtechmm@gmail.com
and I will send to your email.