Wednesday, July 31, 2013

FOMC Report July 30-31, 2013

FOMC Report

July 30-31, 2013

Martin McGuire

The June FOMC minutes and July 17th Beige Book along with intermeeting Fed testimony and speeches indicate a growing confidence in the reliability of forward progress in economic growth and steady progress toward stated dual mandate objectives.  To date, labor market repair has not, on its own, been enough to support a Fed decision to temper monthly additions to monetary policy accommodation provided since January.  However, a more recent up-tic in the level of producer and consumer prices along with consistent progress in the employment situation should be enough to prompt the arrival clear communication about a process for scaling back the size of asset purchases.

There are clearly good reasons why a strong majority of economists expect the Fed to wait until the September meeting (or beyond) to lay plans for tapering the level of securities purchased on a monthly basis.  One reason offered includes the advantage of reviewing of another two months of employment data, additional inflation data and the early-August Senior Loan Officers Survey for further confirmation of mandate progress. Others note the benefit of clarity derived from the Chairman’s post-FOMC conference and question and answer session could help to temper any overreaction to tapering news. 

However, the process of revealing the intention to taper securities purchases has been going on in earnest for more than two months since Bernanke’s May 22 Congressional testimony.  Bernanke seemingly paid a steep insurance premium for early discussion of tapering as equity markets sold off and Treasury interest rates rose.  The stability protection purchased with that insurance premium however, should be expected to pay dividends in the coming announcement for reducing the level of additional accommodative support.   

The minutes from the June FOMC meeting made clear concerns ‘some’ participants had for clarifying the future status of asset purchases; ‘Since the September meeting, some participants had become more confident of sustained improvement in the outlook for the labor market and so thought that a downward adjustment in asset purchases had or would likely soon become appropriate; they saw a need to clearly communicate an intention to lower the pace of purchases before long.’   We might read ‘before long’ as indicating the July meeting rather than waiting until September.

There is too the growing concern Fed officials have in the declining efficacy of the asset purchase program.  Declining budget deficit levels as a result of sequestration and the Treasury receipts from Fannie and Freddie ($66.3 billion in early July) should prompt lower levels of Treasury issuance.  Unchanged level of Fed purchases going forward would have a greater chance of disrupting the Treasury market as those purchases would be a greater percentage of issuance.  Additionally, it is increasingly recognized that continued asset purchases have provided incrementally smaller support to economic growth and employment.  

There were however some concerns voiced at the June meeting that economic agents would misunderstand a decrease in the monthly purchases as a move to a more restrictive policy; ‘Others were concerned that stating an intention to slow the pace of asset purchases, even if the intention were conditional on the economy developing about in line with the Committee's expectations, might be misinterpreted as signaling an end to the addition of policy accommodation or even be seen as the initial step toward exit from the Committee's highly accommodative policy stance.’  These concerns were strenuously addressed in post-meeting communication and we should expect that they will continually be reinforced by Fed officials indicating throughout that any adjustment, either higher or lower levels of securities purchases, is subject to economic data.  

One of the benefits from advising of a plan for the elimination of additional asset purchases is the positive impact it may have on term premium.  As we saw back in 2004-2006, and more recently during earlier dollar-specific LSAP programs (QE1 and QE2) a defined path for policy initiative tends to put pressure on the term premium as it removes some level of monetary policy uncertainty.  A path for reduced asset purchases together with continued assertion that policy rates are expected to remain low for an extended period should put downward pressure on term premium.   

I would argue further that the scope and nature of a tapering plan addressed and communicated at this July FOMC meeting would increase monetary policy transparency and would tend to reduce the potential for market volatility around economic data releases between the July and September FOMC meetings.  By removing the concern about the impact each successive economic data release will have on the prospects for a later announced tapering, the tendency will be toward lesser volatility to attend upcoming economic reports.  More stable markets will support credit extension, consumer and business capital spending and general economic conditions.  

For now, let’s imagine a straight-line reduction to the level of monthly asset purchases from the current level of $85 billion to zero over the 9-10 months remaining from August-September to mid-2014.  If the Fed announces a schedule for tapering the amount of monthly assets purchased to start in August or September, they will likely present a plan to reduce the amount of assets purchased monthly by $8-10 billion until a residual is either rounded up or completed in a final month prior to mid-2014.

Finally, an additional reason for the Fed to announcing the tapering sooner than some have estimated on is the potential for disruption caused by unfilled Fed Board of Governor positions.  There is a potential for as many as four seats to be vacant by the end of January 2014.  Both Chairman Bernanke and Governor Powell have terms expiring at the end of January.  Both or neither may stay, though Bernanke is widely expected to move on.  Powell may stay on in a capacity similar to that of exiting Governor Duke who at the end of August will leave a position she graciously held 1.5 years beyond term.  Finally, Governor Bloom Raskin is a candidate for the position of Deputy Treasury Secretary to be vacated by Neal Wolin at the end of August. 

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