 | Another Meeting, Another Taper |
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| Posted Under: Government • Research Reports • Fed Reserve |
The Federal Reserve did as expected today, continuing to gradually "taper" quantitative easing. At Chairman Bernanke's final meeting, the Fed announced it would reduce its monthly purchases of Treasury securities and mortgage-backed securities by another $5 billion each ($10 billion total) to $65 billion starting in February. This follows a tapering of $10 billion announced at the last meeting in December. As a result, the size of the Fed's balance sheet will continue to rise, but slightly more slowly than before.
The Fed made other changes to the language of the statement that, on net, signal a slightly more bullish outlook for the economy.
First, the Fed said recent data show "growth in economic activity picked up" rather than "economic activity is expanding at a moderate pace." Although subtle, the new reference to improvement in growth recognizes acceleration. If you're driving 45 mph, you're headed to your destination at a moderate pace; if you get to 50 you're getting there faster.
Second, the Fed said household spending and business investment advanced "more quickly" of late. Third, the Fed said fiscal policy "is" less of a drag on growth, rather than "may be" less of a drag on growth.
The one more bearish comment in the statement was describing labor market indicators as "mixed," which just acknowledges the weaker than expected employment report released a few weeks ago.
The Fed repeated that if the economy continues to behave as it expects, with an improving labor market and inflation moving toward 2%, we should expect further tapering in QE in "measured steps at future meetings." In theory, with seven more meetings in 2014 and QE soon to be $65 billion per month, the process of eliminating QE could take until the end of the year. However, given the First Trust economic forecast – real GDP growth of about 3% with inflation of about 2% – we anticipate the Fed will eventually hasten the pace of tapering and end QE in the third quarter of the year. In turn, we anticipate short-term interest rate hikes to start next year once the unemployment rate dips into the 5.5% to 6% range.
The one change from last year is the absence of any dissents, from either the more hawkish or dovish wings at the Fed (represented by Kansas City Fed Bank President Eshter George and Philadelphia Fed President Eric Rosengren, respectively). This doesn't mean the Fed is now moving in lock-step or that those views disappeared. It's just that the dissenters were automatically rotated off of voting membership this year, and happened to be replaced by bank presidents who are less prone to dissent.
As we have written before, QE, by itself, has not boosted economic growth or equity prices and its withdrawal should not hurt either. Instead, QE has simply added to enormous excess reserves in the banking system. The Fed has used QE as way to signal keeping short-term interest rates low. Now the Fed has evidence it can generate this signal without QE. The recent sell-off in equities is not the start of a bear market. Tapering will continue in 2014 and equities will eventually reverse and move substantially higher.
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