Laying Down the Law
The January FOMC meeting must have been a real barn burner. Looks like someone laid down the law on regional presidents speaking a little too casually about tapering. They seem to have gotten the message. We shouldn’t hear any specifics about tapering for some time now. Also, be on the lookout for a more top-down management style ahead.
Earlier this week I highlighted the change in tone from Dallas Federal Reserve President Robert Kaplan. Today we have this from Atlanta Federal Reserve President Raphael Bostic via an interview with Brian Cheung of YahooFinance in response to a tapering question:
So, you know, I basically talk about these things just to give people an understanding that we’re not locked into anything and our policy is actually going to be data-driven. And so I’m going to let the data and the numbers guide how I think about what our appropriate stance for policy is. Now I’ll say my modal forecast is for this economy to be in a place that we’re gonna still need to offer support, and extend that support very robustly. And I don’t want there to be any uncertainty about that, that we’re going to be sort of eager to step back from our support of the economy.
Note Bostic from January via Reuters:
“I am hopeful that in fairly short order we can start to recalibrate,” the $120 billion in U.S. Treasury and mortgage-backed securities that the U.S. central bank is currently buying each month, Bostic said in an interview with Reuters.
What accounts for the change of tone? I think Fed presidents were reminded that the Fed embraced a new policy strategy last year. Back to Bostic:
One other thing I should say — and I didn’t say this in those earlier interviews and that was a mistake on my part — is that, you know our new long-run framework, says explicitly we’re going to be willing to let the economy run hot.
Maybe they got the reminder because they unanimously voted to reaffirm that policy strategy at the January FOMC meeting. The short version of the new strategy is that it is outcome-based rather than forecast-based with the particularly important outcome being that the Fed intends to allow inflation to reach and exceed 2% before raising interest rates. Likewise, asset purchases will continue to run at least at current levels until substantial progress has been made toward the Fed price stability and employment goals. In practice this means, as Bostic explains, the Fed intends to run a hot economy.
What does this mean for market participants? We should expect Fed presidents to reveal their forecasts for growth, unemployment, and inflation but avoid frontrunning either the actual data or the implications for policy. They will refrain from making calendar-based policy forecasts and from appearing eager to remove accommodation. The latter is important; Federal Reserve Chair Jerome Powell likely wants to avoid spooking the markets by frontrunning policy as well by any talk about tightening that turns into a self-fulfilling prophesy. As in “we talked about this so much now we have to do it.”
Speaking of Powell, note what St. Louis Federal Reserve President James Bullard said here in this via Steve Matthews at Bloomberg:
“We are still in the middle of a crisis, so it’s too early to initiate that discussion,” Bullard told reporters Wednesday after a speech to the CFA Society St. Louis. He said he would “look for leadership from the chair as to when we would want to initiate a discussion about that.”
That phrasing “look for leadership from the chair” is something to think about. It sounds like Powell is taking on a very Greenspan-esque, top-down management role as if he will tell the presidents when it is time to talk about tapering. This could be very important in setting up a discontinuous break in communications. As I said earlier this week, we should be anticipating the change in policy before the Fed talks about that change. If Powell is taking charge, we may get few little rumblings before that change. It will all be deny, deny, deny followed by a big announcement. The data should already be bringing us to that point if the Fed is communicating the meaning of “substantial progress” so it shouldn’t be too jarring, but it is clearly something to be watching.
Bottom Line: Expect the Fed to let the economy run hot. The Fed is erring on the side of overshooting. That is the message we should be hearing. We shouldn’t be hearing much more about taper timing until both the data turns decisively in the direction of “substantial progress” and Powell agrees that the data has turned decisively.