Last year at the January 2013 FOMC meeting the Fed took a breather following the significant policy changes that took place at their December 2012 gathering. We should expect the Fed to again leave well enough alone at this weeks meeting. Last year the Fed paused in January after having added longer-term Treasuries to their open-ended agency mortgage backed securities purchase program and initiated ‘threshold’ guidance for policy rates. This December just past the Fed announced the start of a tapering of the purchase program offering forward guidance on the path for tapering while providing further qualitative guidance for the policy rate.
The weaker employment report earlier this month came at a relatively opportune time for Fed policymakers. Had that report come a month earlier, it may have caused a delay in initiating a scaling back of securities purchases, causing increased concerns about the programs efficacy. The Fed did announce tapering plans at the December meeting, met thereafter with declining Treasury yields as economic agents were heartened by an understanding of the a policy-path description in the taper plans (see ‘Unconventional Policy Guidance; Then and Now’ below).
(see also ‘FOMC Report December…’ for further discussion)
Treasury yields fell further after a low December non-farm payroll release. In addition to the modest effect weather played on the December payrolls, reports of excess inventory accumulation early in Q4 spooked managers prompting more cautious hiring practices later in the quarter. Fiscal policy debates were also disruptive to hiring plans. Although sever winter weather persists, strong private domestic demand has eased concern for inventory overhang while fiscal policy distractions have abated.
Rarely are economic disruptions seen as a plus by monetary policymakers. In this instance however, the lower Treasury yields resulting from the weak December payroll report and the recently equity market pull-back leave the Fed apt to accept the potential economic benefit from these lower Treasury yields as a gift not paid for in greater levels of monetary policy accommodation. We should therefore not expect either the lower payroll number or equity weakness to dissuade the Fed from following their ‘policy-path’ for per-meeting taper plans.
Unconventional Policy Guidance; Then and Now
At each application of LSAP, Treasury yields reached a nadir at or shortly after a programs announcement. In each of these purchase programs, details about the size of the program, period specific application and in most cases its ending date allowed economic agents to construct a present value for the policy impact. The ability of economic agents to discount the benefits of the purchase programs resulted in the lowest yields being found at or near the announcement of the program. Thereafter, while economic benefit continued to be derived and the application of the purchase program continued to offer support, the impact on Treasury yields diminished throughout those programs in accordance with the discounted nature of that support.
I have argued that recognition of monetary policy path by economic agents can result in a powerful economic support. Where this understanding of policy intent is quantifiable and discriminates along a timeline, economic agents are capable of discounting the present value of that support. The ability of economic agents to discount the expected benefit from clearly defined LSAP programs is believed to be the reason why Treasury yields reached their lowest levels at or near the start of these programs.
In keeping along these general lines and bringing this theory closer to today’s situation, we might consider the implications for economic agents understanding the policy intent in ‘measured steps’, as described in the December FOMC statement, ‘the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings’. The Fed has afforded economic agents a timeline with discrete intervals (FOMC meetings) and a likely interval value $10B reduction in purchases. The language ‘further’ helps to describe the December FOMC announced $10B reduction in purchase plans from $85B to $75B as ‘the’ example of ‘measured step(s)’.
With great confidence then, economic agents can build-out to very exacting detail the likely policy path for tapering of the purchase program. By outlining this policy path, the Fed has been able to partially offset a negative reaction to a reduction in the purchase program. To the extent that the purchase program was already largely expected to be removed, the Fed’s forward guidance for the purchase plan could have had a net bullish effect on Treasury prices. However, just as economic agents were quick to discount the value of LSAP programs at announcement, we should expect that the benefit, in lower Treasury yields from this ‘know’ policy-path of tapering has also been discounted. All else equal, we should see yields rise as time passes as the benefit from the known policy-path for tapering is realized.
In the current situation as regards the tapering plans, economic agents largely share the same basic outline for how the Fed will proceed. There are certainly some who differ in their opinion as to how the tapering might proceed. However, a strong majority expect the Fed to taper at $10B per meeting and to wrap the program up around October this year.
Importantly, it is not necessary that all economic agents agree on expected policy path in order for the Fed to engender economic support from forward guidance. By providing enough information to allow economic agents to gain greater confidence in their expectation for policy prescriptions, the Fed will induce these same agents to take on greater levels of risk as matches their greater levels of certainty.
Policy Direction from this Meeting
- On Overnight Reverse Repo Program (ON RRP);The Fed has been successful in testing this policy instrument that will one day hold an important place in matching the need for control over excess reserve balances with the target policy funds rate. The trial period is scheduled to conclude on January 29, but overwhelming support for an increasing the per-participant daily allotment from $1B to $3B at the December FOMC meeting leaves little doubt of support for the ‘testing’ period to be extended. The ON RRP is unlikely to find any idle time, instead it will eventually elevate it to active policy status when the need is apparent. The Fed will take care over the coming quarters not to excite unintended suspicions of restrictive policy intent in further testing of this program.
- No change expected in ‘policy-path’ guidance for tapering.
- No change expected in policy rate guidance.
- Possible upgrade in statement about current economic conditions.