Divyang Shah, Senior IFR Strategist
We have had plenty of Fed speakers since the FOMC meeting trying to point out that the market has got it wrong when it comes to the outlook for the Fed Funds rate.
We are likely to get a further rendition of this theme when Bernanke delivers his testimony to Congress on July 17 and 18. Once again this is likely to fall on deaf ears as the market believes that a Fed that is focused on ending QE with an implicit 7% trigger on unemployment will also look to hike interest rates with a more explicit threshold of 6.5% on unemployment.
The Fed is keen not to add further stimulus to the economy despite the fact that it is missing on both of its mandates. This is about a shift in the balance of risks whereby the Fed cannot keep its foot on the accelerator even if it feels that the time to step on the brakes is some distance away.
A forward looking Fed forces the markets to be equally forward looking so we should expect the Fed having to stomach the current price action.
There is the possibility that the Fed will want to make sure that the economic momentum will be maintained and taper in December instead of September.
But our view remains that September remains live when it comes to the start of tapering and this will likely involve a reduction in the pace of MBS and Treasury purchases by US$10bn each or US$20bn combined.
