Well, the Federal Open Market Committee finally bit the bullet and began its long awaited downward adjustment in the flow of its one year old $85 billion a month in bond purchases. Our sense going into the pre-meeting blackout was of a modest lean against a first taper in December, but that, it would be a tactical decision between December and January on when to start, and that the decision would ultimately entail some trade-offs across the FOMC (see SGH 11/26/13, “Fed: Thresholds and the Taper”).
They did taper, and above all, the broader tactical decision built around trade-offs is exactly what we got. And even better yet, Chairman Ben Bernanke seems to have pulled off an unusually smooth policy move in light of the muted bond market and a happy stock market.
*** In hindsight, the minimal taper reflects the “changing the mix” messaging the FOMC wanted to drive home in a way that wasn’t there in September, and looks to have come through a trade-off between a relatively low risk earlier first wind down of QE support to the recovery for what was a powerful dovish guidance on rates. In that sense, the decision today provides an ideal backdrop to the transition in the chair from Ben Bernanke to the incoming Janet Yellen. ***
A Linear But Flexible Taper Timeline
The timeline the FOMC has mapped out, of a very “measured” taper at each meeting through late year, provides a base case road map that a clear cross section of the Committee wanted to put into place. At the same time, it also maximizes the FOMC’s flexibility since the flow adjustments are not on a pre-set path; the decisions on whether and by how much to taper will be made at each meeting, so the pace can be accelerated if growth breaks north of the projections or can be paused if growth looks to be sliding south of its 3% midpoint between the 2.8% to 3.2% real GDP range for 2015. In other words, the hawks got their start to the taper, and a timeline to end the bond purchases altogether, so it is no surprise that Kansas City’s Esther George finally withdrew her dissent.
The decision to taper at this meeting did surprise us a teeny bit in that it suggests the Committee is indeed comfortable in betting the economy is near enough to an “escape velocity” of self-sustaining growth to warrant pulling the taper trigger rather than waiting for some more reassuring data. That seems to have been the line Boston’s Eric Rosengren was unwilling to cross, and though his was the only dissent, he is not alone in that concern, and his dissent marks a strong undercurrent of dovish discomfort that will run through the course of next year.
But the more dovish-leaning who did not want to risk a premature withdrawal of the QE accommodation nevertheless got the optionality to pause (and, they will insist, to potentially ramp the purchases up again) along that presumed gentle path of unwinding QE next year. The doves also got, in effect, a big boost in the total stock of the open ended QE regime to probably just north of the $1.5 trillion mark first broached by Chicago’s Charlie Evans, which is probably well beyond the wildest expectations of many doves.
But where today’s taper works well is in the context of the FOMC’s long-running “changing the mix” messaging for the accommodation best suited to support the economy at this stage of the recovery: in keeping to its word in putting more of its reliance in its accommodative support on the lower for longer rates, the Committee reinforced the forward guidance on rates in the formal statement and offered an even more remarkably dovish movement in the dots guidance in the attached Summary of Economic Projections.
We were expecting the more dovish forward guidance on rates to be highlighted by elevation into the actual statement, which they did by inserting the reinforcing declarative sentence that “The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.” Against some market expectations, they also opted against dropping the 6.5% unemployment threshold lower, which was as we had expected.
And reflecting the persistence in the extremely low inflation, the FOMC accented its concern by adding even more of a dovish tone to the statement by re-phrasing the inflation sentence that it is “monitoring inflation developments carefully for evidence” that it is indeed moving back north to where they are expecting it. If not, will it alter its pace of tapering bond purchases, or will it be addressed on the rate side? On that we will have to wait and see how the first half of next year goes, but our guess is the latter.
Those Dovish Dots
But it is the even low rate projections in 2015 – implying a bunching of the first rate hikes into the fourth quarter of that year – and what looks to be an even more flattened trajectory into 2016 once the rate tightening is underway that to us really stood out.
One year of first rate hike moved from 2014 to 2015 and a 2015 dot migrated into 2016 as we thought might happen. The 2015 dots in general moved unmistakably more dovish, with six now at 50 basis points or less compared to only three in September, and 12 were at 1% or less, and interestingly, even the fierce hawks all seemed to soften a bit on their rates projections, with only one still at 3.25% in 2015 and two others collapsing their yearend 2015 rate projections to either 2.75% and the other all the way down to 2%.
The 2016 dots also moved south to a more dovish trajectory, with nine at 1.75% or lower and five no more than 1.5% compared to three in September, and the dots at 2% or more fell from nine to eight, while the most hawkish went from 3 to 2 at 4% or more. It is also worth noting that the FOMC also lowered its longer run neutral funds rate again, with six now at 3.5%-3.75%, and only two compared to three above 4%.
Taking that in, it left us thinking that Vice Chair Yellen got more movement than she could have hoped for towards the “lower for longer” and “slower for longer” optimal policy path she has championed. So in that sense, the minimal taper and a flexible taper path with plenty of optionality looks very tactical indeed and would seem a small price to pay for a more solid looking consensus going into what will be an interesting 2014.