The FOMC statement tomorrow is highly unlikely to offer much, if anything, in the way of substantial policy changes. In that sense, the Minutes to the meeting in three weeks may prove richer in content than the statement itself. But that does not mean the two day meeting will be uneventful.
*** The Fed is probably more confident in the resiliency of the recovery than the market, while it is also likely to retool its communications strategy at this meeting to put the accent on forward guidance on rates rather than QE. The recovery will indeed be supported with as much accommodation as needed, but we expect a shift in the terms of the QE debate to also begin at this meeting toward the costs and efficacy of QE. That may, in turn, soon show up in forthcoming speeches to temper some of the more extreme recent “QE forever” expectations. ***
*** Changes in the Numerical Thresholds are also likely to be discussed at this meeting, although the actual changes seem unlikely before the December meeting at the earliest. But once the market moves beyond its fixation on the taper, those looming adjustments to reinforce the lower for longer rates forward guidance could have the sort of impact on short rates the Fed is striving for in its overall communications efforts. ***
An Outlook less Bleak
A lot has obviously been made over the loss of data during the shutdown and more importantly, how noisy the data is likely to be in its wake. It will thus be difficult for a while to get a high degree of clarity in the data, which is tough in the best of times.
It will be also be interesting to see how the deflation risk is phrased in the statement. The FOMC has to date stuck to its insistence the persistence in well below target inflation will be transitory. At least acknowledging the persistence in the low inflation may be warranted.
In addition, an effort has to be made to disentangle the short-lived versus more lingering effects in the hit to confidence to consumer and especially business investment. That low signal value of the recent data is thus likely to add an extra layer of variance around the central tendency forecasts prepared for the meeting.
That, however, is not the same as saying the FOMC will be flying blind on the outlook. The forecasting models are built around a long trendline in which the most recent data points are only plotted in to sketch out whether the projected trajectory is holding true or veering under or over, to the left or to the right.
Our sense is that the Fed remains reasonably confident there is an underlying strength to the economy that will keep the recovery well intact on the other side of the shutdown data daze. The Fed, in other words, is unlikely to share some of the market’s gloominess on growth in the wake of the shutdown or in taking the delayed September Nonfarm Payroll print to mean a marked slowdown.
So while we expect the descriptive first two paragraphs of Wednesday’s statement to acknowledge the slowing of momentum since September, we suspect the Fed will stop well short of validating the pessimism on near term growth being used to justify the drug-addicted like chatter of QE forever and a first taper being pushed into the second quarter and beyond next year.
Messaging Re-set on Two Fronts
The lengthier and liveliest discussions are likely to revolve around how to fix and clean up the Fed’s badly mangled communications strategy. We think it will come on two fronts.
First, as we have written previously (see SGH 10/1/13, “Fed: Forward Guidance, Fiscal Retrenchment, and the Taper “), the FOMC will begin the repair and reinforcement of its forward guidance on lower for longer interest rates and the “slower for longer” trajectory of rates once the Exit tightening is finally underway. Again, as we have been stressing, a key reason for the hesitation on that first taper in September was the anxieties a weakened forward rates guidance would have undermined the Fed’s ability to dampen any further yield increases once the actual taper was underway.
In other words, it was not just the surprise spike in yields (OK, a surprise to the Fed anyway) that was the issue, but how much higher yields could have gone from there that drove the September no taper decision.
So we suspect the meeting over the next 48 hours will include lengthy discussions over the need to put an emphasis on the forward guidance as the primary policy tool, something that most of the FOMC already agrees.
In one sense, that task has been made that much easier in recent weeks because, one, a dovish-leaning Vice Chair has finally been nominated by the White House to succeed Ben Bernanke next February, and everyone knows where she stands, thus ensuring a safe continuity. The other reason is, of course, the southerly slippage in the recent data, which makes lower for even longer rates an easier sell.
That in a way points to the second communications clarification likely to be underway at this meeting, namely the “changing the mix” message that QE can be wound down without reducing the enormous, perhaps even greater, accommodation being provided by the forward guidance on rates.
Extending ample accommodation is not the same thing as continuing with the current pace of bond purchases. For the Fed, it is not QE but the lower rates and slower tightening that is the more powerful of the two policy tools at the zero lower bound.
Their dilemma is in that sense a communications one, how to get the “changing the mix” messaging reaffirmed in market expectations to ensure a cleaner “hand off” from the bond buying to the reinforced rates guidance. That is a huge difference that seems to be getting lost.
Balance Sheet Concerns on Horizon
And like an undercurrent to this is the lingering concerns over a balance sheet whose size is simply creating too many potential problems during the eventual Exit; some FOMC members do not think the balance sheet is anywhere near a size to warrant such anxieties, but most members do have a number in the back of their minds where they do start to feel discomfort.
That number for most is somewhere a little north of the $4 trillion to $4.2 trillion mark, which is neatly around the same $1 trillion plus of the stock of the additional accommodation even the doves had envisioned as the upper bound of what is likely to be needed in the open ended regime. Beyond that number, with some give and take, even the doves will want to see clearer evidence of QE’s benefits to justify the potential costs down the road.
Increasingly then, certainly by the time of the December meeting and through the first quarter of next year, Fed officials seem likely in their speeches to accent a shift the terms of the Great Taper debate from the labor market to these cost/benefit and efficacy issues. That is even more likely to be the case after the turn of the year when the voting members of the FOMC will include two well-known hawks. Even if their votes are isolated, there is going to be greater weight given to the concerns they share about the balance sheet.
Of course not all, if any, of this may become readily apparent in the statement tomorrow. The statement may in fact be left as bland as can be. And the majority of the FOMC is probably unlikely to have any problems with the current yield levels and finally getting the taper question pushed off the agenda for a while.
But we do think the thrust of the discussions today and tomorrow are likely to be along the lines laid out here, which will color the public remarks going forward.
“I’m Waiting for the Man” – Lou Reed and the Velvet Underground, 1967.