The Fed’s decision last night not to start its tapering process, in spite of almost universal expectations fuelled by the Fed itself that it would, has been both welcomed by financial markets, which have rallied hard in its aftermath, and characterised as the FOMC losing its nerve. But the decision not to start tapering was arguably a braver one than if it had meekly done what the market expected. While seemingly happy with the economy’s recent rate of growth, the Fed is clearly concerned that the economy will not kick on from here, weighed down by the (largely Fed-induced) tightening in financial conditions seen since May and the prospect of further fiscal tightening, or even a government shutdown, as a result of ongoing budget negotiations. Given these uncertainties, and with inflation running below target and wage growth negligible, not tapering now made more sense than just blindly going ahead.
So, where does that leave us? Well, a bias towards tapering clearly remains in place. The Fed continues to expect the economy to build up steam from here, forecasting growth of 2.9-3.1% in 2014 and 3.0-3.5% in 2015. Unemployment, meanwhile, is expected to continue to fall, dropping below the 6½% threshold most likely in 2015. Reflecting this, the median expectation of the FOMC is that the FFR will be at 1% at end-2015 and 2% at end-2016 (yesterday was the first time the Fed had produced a 2016 forecast). And, eventually, the Committee sees rates rising to 4% in the longer term, although Bernanke suggested at his press conference that this level might not be reached until 2018 or even 2019.
So, the Fed is still looking to tighten. But the start date appears to have been put back some way, possibly into next year. Bernanke provided three interesting insights in his press conference. First, he opened the possibility that tapering might not begin until next year. He noted that the plan outlined in June remained largely in place and that the first adjustment could “possibly” occur this year. When asked by a reporter to clarify the meaning of “possibly”, Bernanke simply indicated that there was no set schedule and that decisions would be data dependent -- in other words, the first reduction in purchases might not occur this year. Second, Bernanke had indicated in June that officials expected the unemployment rate to be at 7.0% when the FOMC ended the purchase program in mid-2014. That guideline no longer seems operative. When asked about this reference point, the Chairman noted that the Committee would take a broad view of the labour market and that there was not one magic number for ending the program – in other words, forget about the 7.0% guideline. Finally, the first tapering need not occur at a meeting that involves a press conference. Bernanke noted that the FOMC holds eight meetings every year and policy could be adjusted at any gathering.
So, having expected greater clarity from last night’s meeting, the market is left with perhaps even greater uncertainty than before over when the Fed will begin to taper. But what we have learnt from last night is that the Fed is not looking to taper at all costs – if its fears about the impact of the tightening in financial conditions on the housing market in particular and/or the potential impact of fiscal outlook materialise, they will continue to delay. But with the impact of tighter financial conditions likely to take some time to become clearer, and with uncertainty over the fiscal position set to persist, the odds of tapering being held off until the new year now look short.
Michael Moran, Chief Economist, Daiwa Capital Markets America
Grant Lewis, Head of Research, Daiwa Capital Markets Europe Ltd.