The Fed has the coin and isn’t about to flip it
By Jason Martin
Date: Thursday 26 Apr 2012
The Federal Reserve published its statement last night and investors remained on edge as they listened to Chairman Ben Bernanke’s press conference looking for signs of monetary policy initiatives. Little light was shed on the future as both tightening and loosening remain on the Fed’s table and Bernanke promised, as always, to do what was needed.
THE SHIFT BETWEEN STATEMENTS
Comparing last night’s statement with the one from the prior meeting on March 13th, there were scarce changes in the wording. Only the first two paragraphs of the five-paragraph statement showed minimal adjustments. Nonetheless, it’s quite clear that the present isn’t as bright as before and inflation only entails the slightest of worry. Nonetheless, the improvement expected in the American economy has come a little bit closer.
Labour market conditions have only “improved” in this round of the game, compared to the “improved further” used in the March statement. Though the unemployment rate has moved down, the Fed notes now that is has only “declined” compared to the previous “declined notably” terminology.
Inflation has now “picked up somewhat” though the Fed continues to believe that the effects of higher energy prices are only temporary and that “longer-term inflation expectations have remained stable”.
Once again the Fed expects “growth to remain moderate over coming quarters”, but this time around adds that it will “then pick up gradually”. It is perhaps little more than a nuance, but we are talking about the Fed and it clearly denotes a slightly more positive tone.
QE WHAT?
In the press conference, Bernanke gave few hints of any change in Fed policy. “A highly accommodative stance of monetary policy is warranted in light of persistence of factors restraining the pace of recovery and the ongoing risk to the economic outlook,” he insisted. He added that it is the Fed’s intention to maintain that stance for the “foreseeable future”. This is no new information if we consider that rates have been promised to be kept at exceptionally low levels through “late 2014”.
Most experts were looking for ways to gauge the Chairman’s thoughts on the possibility of QE3 (implementation of a third round of quantitative easing). General interpretation of his stance in the press has been somewhat taken out of context. Bernanke was asked directly for the possibility of QE3 and he responded as follows: “We remain entirely prepared to take additional balance sheet actions as necessary to achieve our objectives. Those tools remained very much on the table and we would not hesitate to use them should the economy require that additional support."
What really needs to be kept in mind when contemplating the message here is that it says nothing at all as it is typical Fedspeak. In other words, would Bernanke ever say that the Fed was unprepared or that it would not take action if the economy required it? What has been left out of a lot of press reports is that Bernanke made the position clear: “For the time being, it appears that we are more or less in the right place.”
Analysts at the Economist Intelligence Unit put the Fed’s position in plain words: “At the moment we're in a curious position, where the risks seem to be balanced on the upside and the downside with the economy. As unsatisfying as it is, it doesn't need any great monetary tightening or loosening from the Fed.”
Channel Capital Research classifies Bernanke’s behaviour as QE2.5. “It’s almost like he’s trying to keep a trading range. Every time people get too buoyant he comes out with a dour review and every time they get too depressed he says the Fed has your back. He’d rather be known as the Fed chairman responsible for 3% inflation than 20% unemployment,” the broker says.
Contrary to most press reports JP Morgan considers that QE3 may “still on the table, but it’s getting closer to the edge of falling off”. They remind us that the Fed increased the growth estimate for this year to a 2.4-2.9% rise from the prior 2.2-2.7% estimate and that more easing would only be implemented if growth deteriorated.
Finally, Wall Street bond dealers now put the probability of more easing at only 28% according to a Reuter’s poll, while experts such as Nomura or Barclays no longer expect further bond purchases.
LESS DOVISH STANCE ON RATES
As far as interest rates are concerned, the vote to keep them at the historically low 0-0.25% came out nine-to-one. Richmond Fed President Jeffery Lacker dissented against the statement for the third time in a row based on his belief that an increase would be needed before the “late 2014” language.
No new news there, but the newest projections released by the Fed show that the most dovish members no longer want to hold off on the rate hike until 2016. Now seven officials think 2014 is appropriate as opposed to prior five noted in January, while only four prefer to wait longer, compared to the earlier six.
Fixed income experts at Columbia Management comment that they “wouldn’t call it hawkish. It’s more that (Fed members) are less dovish”.
Moreover, Fed fund futures now put trading bets for a rate hike at March 2014, one month earlier than prior to the statement and Bernanke’s conference. So while Bernanke and his colleagues haven’t completely thrown out the possibility of more easing the future improvement expected in the American economy makes it more worthwhile to wonder about when the Fed will begin its tightening, rather than the implementation of any type of QE3.
As Capital Economics puts it: “The Fed’s best option is to stay on the sidelines waiting to see which way the recovery breaks”. Bernanke went a long way to show no change in policy stance, but market clues seem to have made an ever-so slight shift towards tightening.
It’s probably too early to place our bets. Bernanke still has the coin and he isn’t going to flip it. More likely he’s telling us, “heads I win, tails you lose”.
JM
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