Fed: Pointing to More than a Pause

Published on September 18, 2013

No two ways around it, we were taken aback by the Federal Open Market Committee’s decision not to taper even by the increasingly gentle and by now uncontroversial $10 billion we had come to expect.

We even had to let Chairman Bernanke’s press remarks sink in a little before reacting, for at times he sounded like he was justifying the reasons for a taper, only they didn’t, and not to be rude, but the logic of his explanations were tortuous at times if not often contradictory.

*** Something clearly spooked the Committee about going forward with even a minimal first taper, and we would worry the hurdle to a first taper has now been made that much higher. The FOMC, probably more by default than design, may have boxed itself into a corner, limiting its ability to begin its intended gradual wind down from QE anytime soon, perhaps not even before next year, and in effect putting that decision in the hands now of the next Chairperson. ***

*** We are also wondering aloud whether the decision today may mark not just a plea for more data —

it seems more likely than not the data is not going to be markedly better in the coming weeks — but a policy reversal from the momentum that was building inside the FOMC since the June meeting consensus, however strained, to reaffirm the likelihood of a first taper “in the next few meetings.” ***  

 *** But in the end, the argument that however strong the sentiment to begin a downward adjustment in the flow of its $85 billion a month in bond purchases, the dovish inclination to avoid a premature move until the recovery is locked down simply won out, albeit potentially extending the life of the QE for longer than the FOMC may anticipate. ***

It may also prove to be difficult for the Fed now to get a firm hand on its forward policy guidance in the next few weeks.

Lacking Firm Conviction

All that said, we did note in our last report (see SGH 9/9/13, “Fed: Where the Votes Are”) that what we thought was a more likely, albeit minimal, first taper of $10 billion “lacked firm conviction” and that there was a lower probability but real chance they could punt the taper decision into October. And the Chairman did in fact as we expected, effectively turn October into a “live” meeting by noting they could potentially tack on a press conference ‘if needed” (memo to the FOMC, yes it will be).

But the Chairman’s tone throughout the press conference seemed defensive to our ears and pockmarked by contradictions between the FOMC’s take on things that seemed to point to a taper and the decision instead not to taper, or at least to wait for further data. The Chairman hardly offered any certainty, or conviction if you will, that they could indeed taper in October. It now seems very unlikely they will or can, and if they did taper in October, they will have to come up with a pretty impressive explanation to justify it unless they get bailed out by the data.

What’s more, in pointing to anxieties over rising yields, the FOMC may have inadvertently created a nasty but unintended feedback loop of policy paralysis in that every time they make noises about tapering, it will only drive yields higher and keep them in QE for longer than ever imagined.

Perhaps the escape clause is that yields will be rising for “good” reasons, the data unmistakably pointing to a more self-sustaining recovery. But it seems unlikely to us there is going to be any substantial improvement to speak of in the near term data that would suddenly warrant a first taper that didn’t exist at this meeting. If anything, the data may turn down or at best, simply indicate an economy that continues to bump along at its same very gradual, somewhat subpar pace of growth. Where would that scenario leave the Fed?

At least the forward rates guidance — what we in fact thought would be the most difficult part of the policy messaging to get across — came out almost right in line with expectations. The main cluster of year-end fed fund rate projections in 2015 were nudged down to reflect the downward adjustment in the 2013 real GDP projections, and more importantly, that first glimpse of the 2016 rate projections did indeed display only a gradual rate tightening trajectory, with the 2016 cluster between 1.75% to 2.25% by year-end.

But then, the intended effect of the lower for longer rate guidance may have gotten buried somewhere deep under the larger takeaway of the decision not to taper.

The Chairman also affirmed what we had expected to be a decision against toying with the unemployment or inflation thresholds. As we wrote, adjusting either or both looks like a decision for down the road, namely, for the next Chairman.

New Market Speculation

On that point of what is being left for the new chairman, the intense and damaging speculation whether Lawrence Summers or Janet Yellen would be the next Fed Chair may soon be replaced by new speculation over why the FOMC blinked on the taper.

For one, it is probably going to be a matter of days if not hours before the trading desks and Washington blogs will be speculating on whether the curious story, just minutes before the FOMC announcement, quoting a White House source anonymously asserting Fed Vice Chair Yellen is indeed the front runner to succeed Chairman Bernanke, may be pointing to an unholy trade-off between a delay in the taper for the sake of the 2014 midterm elections in return for certainty over the chairmanship.

An apparently tone deaf White House is already within hours of the surprise non-taper decision lobbying the Hill to suggest it is likely to be Yellen and that the decision may come as soon as next week. But the real impact of all this is probably going to be to make the confirmation that much messier, and could add another blow to the Fed’s independence.

Second, and related, speculation has already started to mount over whether or not the decision not to taper was indeed driven by Chairman Bernanke himself or whether he was essentially overruled or bounced into the decision not to taper.

And as a last concern, in terms of how today’s decision may be taken up on Capitol Hill, there is a good chance it will be seen as a “get out of jail free” card; monetary policy will continue to offset the fiscal drag, meaning Fed policy will be there to stem a further fall in growth due to continued congressional dysfunction, leaving little scope for it to lift the momentum to the recovery as originally intended when the open ended “regime change” was launched a year ago.

Overall, a bad day at Black Rock as the saying goes, and the Fed is going to have to scramble hard in the coming weeks to get their story straight and put the narrative back in place to avoid feeding the very volatility they have long sought to avoid.

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