Fed: Sound and Fury

Published on September 16, 2014

The market and media have been worked into a near frenzy (ourselves included) in the last week or so speculating on the very close call of whether the Federal Open Market Committee will or won’t take the combustible “considerable time” language out of tomorrow’s September meeting statement.

We have no doubt thought this through far too much, but on balance, we still reckon the Committee wordsmiths are probably better off to delete or dilute the potency of the phrase with all its loaded meaning by adopting a new guidance framework in the statement tomorrow. The reason is mostly the consistency they would achieve in doing so relative to the more recent and relevant “sooner or later” rhetoric of the last few months, and the widely shared desire across the FOMC to move further along in the evolution of the qualitative guidance adopted last March.

And even if stays, the troublesome phrase will be neutralized and will almost certainly be coming out anyway in October. In that sense, all this sound and fury over the considerable language being in or out tomorrow seems mostly about the possible trading in the thirty minutes between the statement and the press conference, when Chair Janet Yellen will do her best to walk back any undesired initial market interpretation and reaction.

In any case, it would be impressive to get in front of the communications confusion that, if truth be told, they themselves created, and our sense is that the market pricing and expectations is for the most part providing a moment of opportunity if the FOMC opts to seize on it.

Above all it would be a neat package to unveil the broad revamp to the “Exit Principles” with a realigned more neutral or balanced policy guidance in one go tomorrow, and thus clear the crossed signals on the way to a December meeting assessment of the data and what it portends for a rate tightening timing.

Two Trails to Same Way Station

To do that, admittedly, the FOMC will have to feel pretty confident they won’t be overloading the markets and the public with too much information and, above all, that they can use the rest of the statement and Chair Yellen’s post-meeting press conference to deflect at least some of the inevitably hawkish market reaction that it would be opening a wide door to a March or April rate hike.

Maybe the data in the coming months will indeed bring that long awaited first rate hike “sooner” than expected and into next spring, who knows, but the FOMC is almost certainly unwilling to issue such a signal just yet. And therein lies their dilemma that will have to be resolved by 2pm tomorrow.

The harsh reality they must grapple with is that whether they like it or not, the “considerable time” language is seen as a commitment and promise to mean a rate hike is likely to loom six months from the end of the QE, which draws to a close by the end of October. End of story. So to align the formal statement guidance with the more recent “informal” messaging in recent speeches and remarks, and to maximize a prized policy flexibility to react to the incoming data and the changes in the forecasts towards achieving mandate consistent levels of unemployment and inflation, the FOMC may have to fight its way against a hawkish takeaway by neutralizing the policy signal significance of the phrase.

Up to two weeks ago, the consensus that seemed to be taking shape was to focus September on the broad Exit Principles, the forecasts and perhaps doing a better job of explaining the blue dot rate plots and what role they play in the actual decisions at each meeting on the rate tightening, with some tweaks here and there to tighten up some of the looser accommodative language in the statement. The bridge to December would then be the more organic, natural death of the considerable time phrasing in the October statement once the bond purchases have been brought to a close.

Under this more gradualist approach, Chair Yellen could use the September presser to shrug off the awkward contradictions between the “considerable time” and the “sooner or later” messaging to tee up the messaging transition that looms anyway, and the Minutes could do some of the additional heavy lifting, interspersed with common phrases and rhetoric of the speeches, to make the October statement as obvious as it is painless, clearing the way to the December meeting.

As wrote last week (SGH 9/11/14, “Fed: Word Play”), in the end the decision on what to do with the September guidance will depend on which formulation and sequencing is the most tactical and tactful means to achieve a policy messaging neutrality between now and at least the December 16-17 meeting. That is the earliest a probable FOMC majority believes they will be able to draw from the data-driven forecasts whether the economy is within reach of its elusive escape velocity of a self-sustaining recovery no longer needing such extensive monetary policy support. Two trails to take, in other words, but leading to the same way station in December.

The Evolution of Considerable Time

Along that line of thinking, it is interesting to wonder whether there would be so much heat on the guidance changes in the September statement tomorrow if a press conference was already a given after the October meeting, or if the bond purchases ended in December not October? Or for that matter, not to beat around the bush, what if Federal Reserve Bank of Philadelphia President Charles Plosser had not laid down his pre-emptive dissent in July that has effectively brought the whole guidance issue forward and into the forefront this week?

The considerable time language has itself already gone through quite an evolution. It was first introduced in the September 2012 statement when the FOMC adopted the open-ended Large Scale Asset Purchase program to underscore the “lower for longer” messaging in how policy would remain highly accommodative even after the economic recovery strengthens.

It remained in place after the Numerical Thresholds were introduced in December that year, and went a long way to anchoring the dovish lower for longer forward guidance through the confusion in 2013 over how long the bond purchases would indeed last. In December last year, the phrase was transferred over to its current time-contingent linkage to the start to the taper in the bond purchases, primarily to offset the hawkish implications to winding down QE.

The phrase became even more of the Committee’s workhorse in the March statement. It reinforced the new “below normal” longer run neutral language, and helped to counter the scare in the persistence of low inflation. And as in the start to the taper three months before, it was meant to offset potential hawkish mis-interpretations in the Thresholds being removed for the more “qualitative” (i.e., vaguer) guidance that was itself the start to a more data-driven guidance.

To remove the now two-year-old considerable language would mark the last of the time-contingent guidance after the years of unconventional policy measures. Indeed, just as the FOMC gradually removed the additional stimulus of bond purchases — one of its two policy tools at the zero lower bound — in the taper, so it is now with some lag seeking to remove the stimulus of its other primary policy tools at the ZLB — the forward policy guidance — by removing the remaining time-contingency and taking another step to a purer, vaguer pre-August 2011 qualitative guidance that leaves the market searching the data for clues to the timing to rate hikes, just as the Fed will be doing from here.

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