In the six weeks since the last FOMC meeting there has been almost uninterrupted relatively ‘hawkish’ chatter from Fed members. However, the consensus remains convinced there will be no ‘Taper’ anytime soon – as somewhat evidenced by the following summary of FOMC expectations from Goldman’s Jan Hatzius. So the question is – if, based on the ‘economy’ there is a belief that no Taper will occur – why has the Fed been so ‘hawkish’? We suspect, as we have noted numerous times, the decision to ‘Taper’ (or at least jawbone ‘Tapering’) is not economically data-driven but more a growing concern over technical impacts on the Treasury (fails and collateral squeezes) and mortgage (non-economic spreads crowding out private money and huge build in convexity) market and the bubble-like rational exuberance across every asset class that they have created.
Six weeks of hawkishness…
Via Goldman Sachs,
In our view it would be risky to deliver a hawkish monetary policy message at a time when growth remains sluggish, inflation continues to trend down and market inflation expectations are dropping sharply. While we do not expect the committee to deviate much from the existing message and keep all options open, we anticipate that Fed officials will, on the margin, try to calm markets at the June 18-19 FOMC meeting.
More specifically, we anticipate the following details at next week’s meeting:
First, we expect that the FOMC statement will show only modest changes, focused on the first paragraph discussing the economy. In particular, we believe that the committee will acknowledge the recent decline in inflation by, for example, stating that “measures of underlying inflation have trended lower in recent months.” A minor downgrade of the description of the housing sector might also be appropriate, changing “strengthened further” to “continued to recover.” But we expect no changes to the current language regarding either asset purchases or interest rate hikes.
Second, we anticipate modest changes to the committee’s growth and inflation forecasts in the Summary of Economic Projections (SEP). The mid-point of the central tendency for 2013 real GDP growth was 2.55% in March. But with Q1 growth of 2.4% and Q2 tracking at 1.8% by our estimates, this forecast would require growth of more than 3% in the second half of the year, which seems a stretch in light of the ongoing drag from fiscal policy. We therefore expect the committee to downgrade its 2013 growth forecast by around ¼ point. The core PCE inflation forecasts also look high. We would expect the committee to reduce its end-2013 core PCE forecast by around ¼ point to 1.3% and possibly take down its 2014 numbers by a tenth too. We do not, however, expect any meaningful changes to the unemployment rate projection or participants’ projections for the funds rate (the “dots”).
The risks to expecting no move in the dots appears evenly balanced: while the participant projecting the first funds rate hike in 2016 might move into 2015, one of the participants projecting the first hike for 2014 might move into 2015. The dots probably warrant more attention than usual to see whether the observed changes in market pricing are mirrored in participants’ views on the appropriate path for the funds rate.
Finally, we expect Chairman Bernanke to strike a generally dovish tone at the post-statement press conference.
- First, we would expect him to reiterate that the QE tapering decision is data dependent and would expect him to stick to his statement that tapering “in the next few” meetings is possible if “we see continued improvement.”
- Second, we would expect him to voice concern about low inflation and the drop in breakevens in response to questions about inflation.
- Third, we believe he might attempt to dissuade markets from frontloading too much of the entire monetary tightening process – not just the end of QE but also the normalization of the funds rate – as soon as the committee considers the first step into that direction. He could do so by stressing – as he has done in the past – that the tapering and funds rate decisions are separate in nature. One possibility of delivering this message – which might come up in the Q&A – would be to raise the possibility of lowering the unemployment threshold from its current level of 6.5%. We do not expect this change to occur at next week’s FOMC meeting, but believe it is a possibility going forward.
- Fourth, we would expect Chairman Bernanke to indicate that the committee remains open to modifying its exit principles – in particular, to plan holding all securities to maturity instead of selling MBS – but that no decision has been taken yet. Other things to look out for in the Q&A include any comments on the sharp tightening in financial conditions outside the US and any views on MBS vs. Treasury QE. We would expect him to provide a balanced response to the latter, but at the margin to be more sympathetic to MBS purchases.
Our baseline remains that the committee will first reduce the QE pace at the December FOMC meeting.
In other words – confusion reigns, which is a very different regime (no matter what the talking heads attempt to proclaim) than we have experienced for the last 3 years.