Tuesday, October 29, 2013

FOMC Report; October 29-30, 2013

It appears that the Fed’s attempt to ready economic agents for a reduction to the level dose of additional monthly accommodation had gone terribly wrong.  Though a heavy price was paid that the Fed might better understand the reaction function to tapering plans, it is difficult to see how this information was used, except possibly to have scarred Fed officials from following through with those plans.  Had the Fed been able to follow more immediately from the May 22nd Congressional testimony with a small decrease in monthly purchases, the economic backdrop might look more solid today.                                                             

Of course a majority of Fed watchers were found believing that the Fed was prepared to begin tapering at the September FOMC meeting.  Many recognized that economic growth and labor market conditions were not so strong as to make the case for tapering easy.  However, the Fed having made transparency of monetary policy intent a priority, failed to dissuade this majority from their expectations. 

Without doubt the Fed had made clear that economic growth needed to continue to proceed apace if they were to follow through with tapering plans.  As such, market participants followed economic developments and collectively arrived at the conclusion the Fed had enough reason to begin tapering.  This was expressed by a majority of Fed watchers and indicated further in numerous well-followed surveys.  

It seems likely that it was only when the Fed met on September 17-18, that they came to the conclusion it would be better to spend reputational capital in the form of lost creditability for mistaken transparency than to risk the unknown of taper roll-out.  It is difficult to believe that Fed officials intended to surprise economic agents with a no-taper move in order to create the sharply lower bond and mortgage yields that immediately followed.  That would of course goes against any notion of transparency.

Still, the market was surprised by the no-taper decision with the rate and equity markets reacting immediately and forcefully.  Bernanke has said that the Fed’s level of transparency can be gauged by the extent markets move following the release of the Fed’s FOMC statement.  Clearly, the Fed would be judged opaque of late.

At the time of the May 22nd Congressional testimony which laid out a general guideline for tapering to begin by year end, it was suggested here the announcement was an opportunity to better understand the reaction function for taper news.  To this we further suggested the Fed may have paid a rather substantial upfront premium, in the form of higher Treasury and mortgage yields and lower equity prices, for volatility protection in the future.  

Instead, enough time has now passed that the reaction function to taper news has changed from that understood back in May-June.  We could however argue that the more recent response to the no-taper announcement at the September FOMC meeting updates the Fed’s understanding to this reaction function.  Still, it is reasonable to be concerned about the impact on the economy from these major market adjustments in what some might consider a monetary policy misstep.

Rather than helping economic agents gain confidence by providing valuable insight into policy intent, the Fed has reduced potential economic growth by adding to market volatility around economic releases.  Going forward, economic agents will still be required to analyze additional months of economic data, suffering again the volatility at economic releases in order to again guess when the Fed has seen enough strength (or decreased efficacy) to warrant tapering.  All the while, would-be spending, hiring and investment plans await greater visibility.     

It is difficult to know with any great confidence what damage was done as a result of monetary policy missteps combined with fiscal folly, in the form of budgetary and debt ceiling impasse.  Monetary and fiscal policy-generated uncertainty may have prevented the economy from gaining sought after escape velocity.  However, unless the damage to economic prospects is more severe than apparent in the data released over the last weeks, there is good reason to expect that the current low yield environment combined with additional amounts of treasury and agency mortgage backed securities purchases (despite increasingly diminished efficacy) will help position for stronger growth again by early 2014.  

For the October FOMC meeting, we should not expect any tapering announcement or guidance change.  There may be a reference to recently softer labor market conditions though the outlook for the labor market will likely remain positive.  The FOMC statement might also reference the fiscal budgetary and debt ceiling impasse as having contributed to higher levels of uncertainty and softer growth. 

No comments: