Divyang Shah, Senior IFR Strategist
There is no doubt of the importance of the FOMC meeting this week in providing direction for the market going forward. There will be much to focus on with the post-meeting statement, updated economic projections and Bernanke’s press conference all having the potential for the Fed to refine its message as to the policy outlook.
Post-meeting statement:
How the Fed tinkers with the way in which it assesses growth and inflation will provide clues as to tapering. We are not there in terms of strong signals as to which meeting QE will be tapered. An upgrade of the economic assessment coupled with inflation that is seen as low but below target should be enough to keep tapering expectations alive. Anything more in terms of a growth or inflation downgrade will likely lead markets to doubt tapering as early as the September FOMC.
Economic projections:
In addition to the statement there will be support from the economic projections as they will be used to guide expectations beyond tapering. The forward guidance thresholds will be maintained but the economic projections will provide us with an added dimension. This is especially the forecasts for the Fed Funds rate that could be used to make it clear that higher rates will not naturally follow an end to QE.
Press conference:
Bernanke will use the post-meeting press conference to send two clear messages:
1) some time is needed before the Fed sees “substantial improvement” in the labour market and thus for tapering to begin citing risks related to fiscal policy and potentially inflation, and
2) that the Fed will not raise rates for a “considerable” time alluding to the “considerable period” language introduced in the statement during 2003.
The main task for the FOMC is to deal with the market fears that policy will be tightened soon after an end to QE. The Fed might believe that the economy is progressing to allow it to taper QE but it is not strong enough to justify the move higher on short-term rates. The economic projections and the press conference will be used to hammer home the message that policy will remain accommodative due to ZIRP and forward guidance even after the Fed has stopped expanding its balance sheet.
Given how much work the Fed has done in getting markets to a position where they now believe tapering will happen the data would have to turn very sour over the coming months for the Fed not to taper QE.
The initial step might begin with a small adjustment to MBS purchases and then a pause but there is a strong intent to get the process underway as soon as the Sept FOMC meeting.
