Taper-Tantrum to Successful Policy-Path Guidance
Recent market volatility in fixed income, equities, commodities and foreign exchange is largely the result of greater uncertainty surrounding the path for monetary policy, a situation that will not soon change. A reduction in usable (visibility-aiding) Fed forward guidance accompanies the transition from ‘time’ to ‘data-dependent’ policy guidance. Similar bouts of volatility are possible and even likely until a greater sense of confidence surrounds the timing of the first policy rate increase and its aftermath.
The Fed will announce the end of the securities purchase program (QE3) as initially outlined at the December 2013 FOMC meeting. The ‘considerable time’ language will remain without value adjustments. There is room for a slight and conditioned upgrade in the employment situation and an acknowledgement of moderation in inflationary pressures. However, if these modest amendments are offered in the statement, they will be referenced such that no policy adjustment is implied. Finally, and without consequence, the statement may note recent weaker global growth, reduction in energy prices or the recent market gyration.
Current Eurodollar, Treasury and Fed Fund futures prices and their implied projections for an initial policy rate move in late 2015 as well as current market participant positioning, suggests the risk is for higher yields and for the statement to imply a less dovish Fed policy intent than currently priced in the market.
Volatility and Visibility
Economic agents have become accustomed to a greater level of time-dependent policy guidance. The recent spike in market volatility is an expected outgrowth of the reduction in visibility along the monetary policy prescription timeline. While data dependency has forever been at the core of Fed policy intent, the construction of guidance, using calendar reference has heightened the confidence of economic agents for their forecasts on interest rates and other policy variable levels.
The Fed has offered numerous ‘promises’ to maintain policy accommodation for specific periods or dates in the future. The oldest and still valid time reference guidance was made in the September 2012 FOMC statement; ‘In particular, the Committee also decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.’ So far, this statement has given accurate and visible guidance for more than 2 of its projected 2.75 years of Fed monetary policy timeline. It is difficult to calculate the value of this support. Its ongoing support however, aside from its creditability enhancement is certainly worth less today than it was in late 2012.
Additionally, guidance afforded by the timely regular reduction and elimination of the securities purchase program known as QE3 is also coming to an end. This program initiated as open-ended starting with agency mortgage-backed mortgage securities, advanced to include treasury purchases. It is widely believed, despite St. Louis Fed President Bullard’s urging otherwise, the Fed will conclude the program with an announcement at this meeting. The Fed has no good reason to disappoint in this regard. Some economists have not embraced the notion of the tapering of securities purchases as guidance even though they used this Feds guidance on the path for scaling the purchases in their macroeconomic forecasting models.
Though the reduction in securities purchases from a level of $85 billion per month, begun in January 2014 resulted in gradually lesser amounts of additional stimulus provided, the known ‘policy-path’ timeline advance of those adjustments aided economic agents in their ability to project Treasury and spread rates based on that schedule. To that extent therefore, the guidance provided by the stated intent of scheduled, discrete and calculable changes in the Feds securities purchase plans provided additional visibility along the Feds policy timeline.
A much anticipated approach of the transition from increasing to decreasing levels of accommodation has begun. The transition does not allow for the kind of Fed timeline guidance that provided support while policy goals were further from reach. Timeline references such as ‘mid-2013’, ‘late-2014’ and ‘mid-2015’ have been replaced by ‘timeline-light’ references such as ‘considerable time’, ‘patience’, and ‘some time’. Because of the strong possibility for additional disruptive market volatility on the approach of policy normalization as an outgrowth of reduced visibility, the Fed should be expected to continue to use ‘timeline-light’ references until its first policy rate hike.
Though the continuation of vague calendar or time references about future policy intent will irk some Fed officials, a majority will be expected to carry forward this effort. Therefore, given the reduction in the visibility provided by Fed guidance in the loss of the policy-path tapering and the erosion of time to a mid-2015 policy rate adjustment, we should expect that despite some argument from both doves and hawks, the ‘considerable time’ language is likely to remain until at least December.
Success of Policy-Path Tapering
There was no schedule, reference to process or time until completion offered in the May/June 2013 outburst(s) where then Fed Chairman Bernanke indicated the Fed would likely begin scaling back the level of securities purchases. The latest efforts toward providing monetary policy support at the zero bound (QE3) had been categorically different from previous efforts because this latest program had no stated ending date or limit to the amount of securities eventually to be purchased in the program. As such this program carried a stronger message that the Fed was willing to go to great lengths to insure its success. Any signal or Fed conveyance of interest to end such a program needed to provide a level of detail commensurate with the importance of that program. The lack of that detail offered in May/June ‘13 about the scaling back in securities purchases caused great concern and a dramatic jump in yields.
At the December 2013 FOMC meeting, the Fed outlined a program for reducing the monthly level of securities purchased by $10B and laid out a plan for ending the purchase program according to a schedule that would include regular and similar reductions in amounts purchased. At that meeting the Fed indicated the $10B reduction starting in January would ‘modestly reduce the pace of its asset purchases’. They also noted that if continued progress toward policy goals was achieved they would ‘likely reduce the pace of asset purchases in further measured steps at future meetings.’ By using ‘modest’ to describe the initial purchase reduction and by indicating ‘further measured steps’ for progress, the Fed outlined a detailed ‘policy-path’ for tapering.
Unlike mid-2013, the clear pronouncement of the schedule for eliminating the purchase program gave economic agents an advance preview of forthcoming Fed monetary policy timeline, providing anyone who chose, an opportunity to plot out a path for the winding down of the program, of course conditional on steady expected progress on policy goals. Although the Fed was reducing the amount of additional monthly stimulus, it provided something in its place; visibility. As such there was no adverse reaction as was witnessed in the mid-2013 ‘taper-tantrum’. The Fed had succeeded by using its ability to add visibility to the monetary policy timeline, providing truly usable forward guidance.
Fed Guidance Now
The nature of Fed guidance is changing on the approach of normalization in monetary policy. Timeline references become absent as we near the inevitable policy rate movement above the zero-bound. Less definitive catchwords are used, such as the current ‘considerable time’ which many believe to include at least several FOMC meetings or nearly half a year. This phrase, casually suggested to mean roughly 6 months when Fed Chair Yellen spoke at her first post-FOMC press conference, lost some of that clarity when Fed Governor Stanley Fischer more recently suggested it could mean anywhere from 2-12 months.
The absence of timeline visibility in monetary policy on approach of transitioning from easy to less accommodative policy intent is naturally a period of angst. By forwarding a schedule of intended steps for the process of normalization (‘Exit Plan’), the Fed adds back some level of certainty reduced by their inability to provide timeline or date dependent guidance on the policy rate.
Further, the Fed will likely give some additional information about the timing and process for reducing and eliminating the reinvestment of its portfolio interest and principle receipts. We should expect this guidance to be somewhat similar to the structure of the ‘policy-path’ for tapering. The announcement of that process will provide some timeline policy visibility, offering support during a period of adjustment toward policy normalization.
Of course the Fed’s post-FOMC meeting statement will continue to be a strong source of guidance, as will the Minutes and the Beige Book. All of these regular opportunities for communication can provide a picture of policy stability and foresight, offering both financial and economic support.
The most recent beige book made great efforts to paint a picture that conditions had not changed much at all since the last Beige Book was presented in front of the September FOMC meeting. There were no fewer than seven instances, covering overall economic growth, consumer spending, employment and price pressures, where the pace of growth was indicated to have been consistent with the previous reporting period. The message here is that we should not expect great change in either the statement or the current path for monetary policy despite recent short-lived market turmoil.