 | Yellen Takes Over |
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| Posted Under: Employment • Government • Inflation • Fed Reserve |
Today's statement and (lack of) policy changes from the Federal Reserve was about as dovish as investors could imagine. The statement from the Fed reads as if Chairman Bernanke handed the pen to Vice-Chair Janet Yellen and let her write it instead, which makes sense if he knows something the rest of us don't – about her chances for being elevated to the top spot in the near future.
The big issue going into the meeting was whether the Fed would reduce, or "taper," the pace of net asset purchases from the current rate of $85 billion per month. The consensus was for a reduction of $10-15 billion per month; instead, the Fed didn't taper at all.
The Fed wrote that the pace of asset purchases was "not on a preset course." This implicitly rejected Bernanke's own words at the June press conference that quantitative easing would be finished around the time unemployment hit 7%. When asked about the 7% trigger today, Bernanke treated his old statement like it had the plague, saying there was "no fixed schedule" and "not any magic number" for ending QE, and, that the unemployment rate itself is not a great measure for the state of the labor market.
In other words, don't expect QE to be over when the jobless rate hits 7%, which the Fed now thinks will happen in March 2014. In terms of when tapering might start, the Fed said it wants to see ongoing improvement in the labor market and an inflation rate moving closer to the Fed's 2% target.
The Fed meets again in late October but we doubt that will be enough time for the Fed to change its views on tapering. Instead, we think the very earliest the Fed will start tapering is the December meeting, and then only if it sees some clear and unambiguous acceleration in economic growth.
Given our economic forecast, which is that real GDP growth will accelerate to near 3% at an annual rate in Q4 and continue into 2014, we expect the Fed to taper and then wind down quantitative easing by mid-2014.
For today, the Federal Reserve made several other changes to the text of the statement, all of which were more dovish. It noted higher interest rates and said they could slow economic growth and the pace of improvement in the labor market. The Fed also added language that suggests an increase in inflation from current levels would be more consistent with the Fed's dual mandate. All in all, the Fed set the stage for a much easier monetary policy going forward than it had led the markets to believe over the past three months. So much for transparency.
The one dissent at the meeting was by Kansas City Fed Bank President Esther George, who continued to say policy is overly accommodative.
In addition to releasing its statement, the Fed also provided a new set of economic projections as well as an internal poll on the most likely course for interest rates. Highlights include the following:
- The Fed cut its forecast for real GDP growth this year to slightly more than 2% (from about 2.5%). It also cut next year by a ¼ point to 3%.
- The Fed cut its estimate of the long-term average unemployment rate to 5.5% from 5.6%.
- Only three members (out of 17) thought rates should go up in 2014, versus four members in June.
- The median federal funds target for the end of 2015 was 0.75% versus 1% back in June.
Based on today's statement, lack of policy changes, and the sense that Vice Chairman of the Fed, Janet Yellen, seems to have the inside track to getting the nomination, it looks like, the federal funds rate is not going anywhere until 2015. The Fed's projections say the funds rate will still be about 1.75% in late 2016. And, in his press conference, Bernanke said that it would take two or three more years after 2016 for the funds rate to get back to a more normal 4%.
As we have written many times before, QE3 is not boosting growth, but, instead, is simply adding to the already enormous excess reserves in the banking system. There is little evidence that QE has lifted growth and Price-to-Earnings ratios remain below their levels in early 2008, before QE ever started.
QE is not dealing with the underlying causes of economic weakness at all. The economy has grown slowly, not because of deleveraging, or a recovery from financial problems, but because government is too big. Spending, regulation, and tax rates have all become a bigger burden on the economy – a wet blanket on recovery that the Fed cannot possibly offset.
The good news is that entrepreneurs never give up. New technology continues to left growth. One can only hope that the Fed does not eventually ruin what is left of innovation and creativity by creating too much inflation.
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