Divyang Shah, Senior IFR Strategist
… the problem with trying to draw implications from the data to the outlook for Fed policy is that the FOMC’s judgements are guided to meet “calendar objectives”.
This is what dissenting Bullard revealed last week as the Fed has moved away from trying to meet policy objectives.
The Fed has an objective to taper and then end QE by mid-2014 and incoming data will be interpreted as supporting its objective. This will mean that the Fed will have an inclination to focus more on strength while disregarding weakness in the data. We still feel that Bullard’s comment of last week were not just those of a disgruntled minority voter but a clear insight into what the Fed wants to achieve.
To recap Bullard’s message:
1) the Committee authorised “a more elaborate plan for reducing the pace of asset purchases”
2) confirming that this is not just about tapering but about ending QE with the Committee once again authorising the Chairman to “make an announcement of an approximate timeline for reducing the pace of asset purchases to zero”, and
3) that the Fed has moved away from actions to meet a “policy objective” to “calendar objectives”.
Why else would the Fed choose to ignore low inflation (which has surprised) and focus more on the more predictable trend on unemployment?
It will likely take much more data beyond the Q1 GDP revisions to shake the Fed off its desire to start tapering QE in Sept. The further move lower on gold and concerns over slower growth in China/EM could lead to less concern over the outlook for inflation and inflation expectations – making the Fed less trigger happy in tapering QE early.
Whether its Sept or Dec the key is that the Fed wants to start the tapering process this year and their current objective seems to be to bring asset purchases eventually to zero sometime in Q2/Q3 2014.
NY Fed President Dudley has looked to communicate the nuances of the debate by highlighting that tapering means less accommodation and that market pricing of earlier rate hikes was “out of sync” with Fed thinking.
But Dudley also stuck to the FOMC script in reiterating that the “FOMC anticipates that it would be appropriate to begin to moderate the pace of purchases later this year”.
Bernanke will get a chance to fine-tune market expectations further at his testimony to Congress on July 17 and 18.
