Divyang Shah, Senior IFR Strategist
Bernanke strikes a very cautious note saying that:
1) premature tightening risks slowing or ending the recovery
2) accommodative policy is providing significant benefits
3) the job market is weak overall despite recent gains and
4) reiterating, the Fed will continue bond buying until the labour market outlook has improved substantially.
The expectation had been that the Fed would look to strike a finer balance on the QE tapering debate between the doves and hawks. Instead what we have is a picture that seems to suggest that tapering is less of a risk and if anything the outlook for QE is as balanced as the addition of the “prepared to increase or reduce the pace of its purchases” language that was inserted in the most recent FOMC statement.
The focus on the risks of ending QE early, fiscal drag and focus on the labour market suggests that the bar for tapering QE is very high. This is especially as Bernanke focuses more on the benefits of QE and not yet highlighting the risks.
The lack of a near-term shift toward tapering has provided Treasuries and risk assets with a further boost and this is likely to continue as the major central banks continue to keep their foot firmly pressed on the monetary accelerator.
The BoJ has been a new more significant entrant to the liquidity party and even here the willingness to react in a flexible manner to the recent volatility on JGBs suggests we will get a frontloading of QE. The punch bowl is not only full but is now overflowing with liquidity.
The question for the Fed over the coming months is whether concerns over financial stability will lead to a shift in the tapering debate even if the labour market has not shown sustainable improvement.
Over the coming months the Fed is likely to focus more on refining its “exit principles” before starting to embark on tapering later this year.
