Econintersect: The 30 October 2013 meeting statement presented the actions taken. This post covers the economic discussion during this FOMC meeting between the members. The Fed’s Balance Sheet (which we report on weekly) continues to grow at record levels.
Here is the quote which shook the markets – as it confirmed the Fed was going to cut rates – QE would not continue forever, and the markets would loose this QE dynamic which they believe is pushing up market prices:
During this general discussion of policy strategy and tactics, participants reviewed issues specific to the Committee’s asset purchase program. They generally expected that the data would prove consistent with the Committee’s outlook for ongoing improvement in labor market conditions and would thus warrant trimming the pace of purchases in coming months. However, participants also considered scenarios under which it might, at some stage, be appropriate to begin to wind down the program before an unambiguous further improvement in the outlook was apparent.
Read all about it below.
Econintersect publishes below the views of the FOMC members, and does not go over the reports to the members. We are looking for a glimpse of insight into the minds of the FOMC members.
Participants’ Views on Current Conditions and the Economic Outlook
In their discussion of the economic situation and the outlook, meeting participants generally indicated that the broad contours of their medium-term economic projections had not changed materially since the September meeting. Although the incoming data suggested that growth in the second half of 2013 might prove somewhat weaker than many of them had previously anticipated, participants broadly continued to project the pace of economic activity to pick up. The acceleration over the medium term was expected to be bolstered by the gradual abatement of headwinds that have been slowing the pace of economic recovery–such as household-sector deleveraging, tight credit conditions for some households and businesses, and fiscal restraint–as well as improved prospects for global growth. While downside risks to the outlook for the economy and the labor market were generally viewed as having diminished, on balance, since last fall, several significant risks remained, including the uncertain effects of ongoing fiscal drag and of the continuing fiscal debate.
Consumer spending appeared to have slowed somewhat in the third quarter. A number of participants noted that their outlook for stronger economic activity was contingent on a pickup in growth of consumer spending and reviewed the factors that might contribute to such a development, including low interest rates, easing of debt burdens, continued gains in employment, lower gasoline prices, higher real incomes, and higher household wealth boosted by rising home prices and equity values. Nonetheless, consumer sentiment remained unusually low, posing a downside risk to the forecast, and uncertainty surrounding prospective fiscal deliberations could weigh further on consumer confidence. A few participants commented that a pickup in the growth rates of economic activity or real disposable income could require improvements in productivity growth. However, it was noted that slower growth in productivity might have become the norm.
Business contacts generally reported continued moderate growth in sales, but remained cautious about expanding payrolls and capital expenditures. Manufacturing activity in parts of the country was reported to have picked up, and auto sales remained strong. Reports from several Districts indicated that commercial real estate and housing-related business activity continued to advance. In the agricultural sector, crop yields were healthy, farmland values were up, and lower crop prices were increasing the affordability of livestock feed. Wage and cost pressures remained limited, but business contacts in some Districts mentioned that selected labor markets were tight or expressed concerns about a shortage of skilled workers. Reports from the retail sector were mixed, with remarks about higher luxury sales and expectations for reduced hiring of seasonal workers over the upcoming holiday season. Uncertainty about future fiscal policy and the regulatory environment, including changes in health care, were mentioned as weighing on business planning.
Participants generally saw the direct economic effects of the partial shutdown of the federal government as temporary and limited, but a number of them expressed concern about the possible economic effects of repeated fiscal impasses on business and consumer confidence. More broadly, fiscal policy, which has been exerting significant restraint on economic growth, was expected to become somewhat less restrictive over the forecast period. Nonetheless, it was noted that the stance of fiscal policy was likely to remain one of the most important headwinds restraining growth over the medium term.
Although a number of participants indicated that the September employment report was somewhat disappointing, they judged that the labor market continued to improve, albeit slowly. The limited pace of gains in wages and payrolls, as well as the number of employees working part time for economic reasons, were mentioned as evidence of substantial remaining slack in the labor market. The drop in the unemployment rate over the past year, while welcome and significant, could overstate the degree of improvement in labor market conditions, in part because of the decline in the labor force participation rate. However, a few participants offered reasons why recent readings on the unemployment rate might provide an accurate assessment, on balance, of the extent of improvement in the labor market. For instance, if the decline in labor force participation reflected decisions to retire, it was unlikely to be reversed, because retirees were unlikely to return to the labor force. Furthermore, a secular decline in labor market dynamism, or turnover, might have contributed to a reduction in the size of normal monthly payroll gains. Finally, revised data showed that the historical relationship between real GDP growth and changes in the unemployment rate had remained broadly in place in recent years, suggesting that the unemployment rate continued to provide a reasonably accurate signal about the strength of the labor market and the degree of slack in the economy.
Available information suggested that inflation remained subdued and below the Committee’s longer-run objective of 2 percent. Similarly, longer-run inflation expectations remained stable and, by some measures, below 2 percent.
Financial conditions eased notably over the intermeeting period, with declines in longer-term interest rates and increases in equity values. Financial quotes suggested that markets moved out the date at which they expected to see the Committee first increase the federal funds rate target. It was noted that interest rate volatility was substantially lower than at the time of the September meeting, and a couple of participants pointed to signs suggesting that reaching-for-yield behavior might be increasing again. Nevertheless, term premiums appeared to only partially retrace their rise of earlier in the year, and longer-term interest rates remained well above their levels in the spring. A few participants expressed concerns about the eventual economic impact of the change in financial conditions since the spring; in particular, increases in mortgage rates and home prices had reduced the affordability of housing, and the higher rates were at least partly responsible for some slowing in that sector. One participant stated that the extended period of near-zero interest rates continued to create challenges for the banking industry, as net interest margins remained under pressure.
After an introductory briefing by the staff, meeting participants had a wide-ranging discussion of topics related to the path of monetary policy over the medium term, including strategic and communication issues associated with the Committee’s asset purchase program as well as possibilities for clarifying or strengthening its forward guidance for the federal funds rate. In this context, participants discussed the financial market response to the Committee’s decisions at its June and September meetings and, more generally, the complexities associated with communications about the Committee’s current policy tools. A number of participants noted that recent movements in interest rates and other indicators suggested that financial markets viewed the Committee’s tools–asset purchases and forward guidance regarding the federal funds rate–as closely linked. One possible explanation for this view was an inference on the part of investors that a change in asset purchases reflected a change in the Committee’s outlook for the economy, which would be associated with adjustments in both the purchase program and the expected path of policy rates; another was a perspective that a change in asset purchases would be read as providing information about the willingness of the Committee to pursue its economic objectives with both tools. A couple of participants observed that the decision at the September FOMC meeting might have strengthened the credibility of monetary policy, as suggested by the downward shift in the expected path of short-term interest rates that had brought the path more closely into alignment with the Committee’s forward guidance. Participants broadly endorsed making the Committee’s communications as simple, clear, and consistent as possible, and discussed ways of doing so. With regard to the asset purchase program, one suggestion was to repeat a set of principles in public communications; for example, participants could emphasize that the program was data dependent, that any reduction in the pace of purchases would depend on both the cumulative progress in labor markets since the start of the program as well as the outlook for future gains, and that a continuing assessment of the efficacy and costs of asset purchases might lead the Committee to decide at some point to change the mix of its policy tools while maintaining a high degree of accommodation. Another suggestion for enhancing communications was to use the Summary of Economic Projections to provide more information about participants’ views.
During this general discussion of policy strategy and tactics, participants reviewed issues specific to the Committee’s asset purchase program. They generally expected that the data would prove consistent with the Committee’s outlook for ongoing improvement in labor market conditions and would thus warrant trimming the pace of purchases in coming months. However, participants also considered scenarios under which it might, at some stage, be appropriate to begin to wind down the program before an unambiguous further improvement in the outlook was apparent. A couple of participants thought it premature to focus on this latter eventuality, observing that the purchase program had been effective and that more time was needed to assess the outlook for the labor market and inflation; moreover, international comparisons suggested that the Federal Reserve’s balance sheet retained ample capacity relative to the scale of the U.S. economy. Nonetheless, some participants noted that, if the Committee were going to contemplate cutting purchases in the future based on criteria other than improvement in the labor market outlook, such as concerns about the efficacy or costs of further asset purchases, it would need to communicate effectively about those other criteria. In those circumstances, it might well be appropriate to offset the effects of reduced purchases by undertaking alternative actions to provide accommodation at the same time.
Participants generally expressed reservations about the possibility of introducing a simple mechanical rule that would adjust the pace of asset purchases automatically based on a single variable such as the unemployment rate or payroll employment. While some were open to considering such a rule, others viewed that approach as unlikely to reliably produce appropriate policy outcomes. As an alternative, some participants mentioned that it might be preferable to adopt an even simpler plan and announce a total size of remaining purchases or a timetable for winding down the program. A calendar-based step-down would run counter to the data-dependent, state-contingent nature of the current asset purchase program, but it would be easier to communicate and might help the public separate the Committee’s purchase program from its policy for the federal funds rate and the overall stance of policy. With regard to future reductions in asset purchases, participants discussed how those might be split across asset classes. A number of participants believed that making roughly equal adjustments to purchases of Treasury securities and MBS would be appropriate and relatively straightforward to communicate to the public. However, some others indicated that they could back trimming the pace of Treasury purchases more rapidly than those of MBS, perhaps to signal an intention to support mortgage markets, and one participant thought that trimming MBS first would reduce the potential for distortions in credit allocation.
As part of the planning discussion, participants also examined several possibilities for clarifying or strengthening the forward guidance for the federal funds rate, including by providing additional information about the likely path of the rate either after one of the economic thresholds in the current guidance was reached or after the funds rate target was eventually raised from its current, exceptionally low level. A couple of participants favored simply reducing the 6-1/2 percent unemployment rate threshold, but others noted that such a change might raise concerns about the durability of the Committee’s commitment to the thresholds. Participants also weighed the merits of stating that, even after the unemployment rate dropped below 6-1/2 percent, the target for the federal funds rate would not be raised so long as the inflation rate was projected to run below a given level. In general, the benefits of adding this kind of quantitative floor for inflation were viewed as uncertain and likely to be rather modest, and communicating it could present challenges, but a few participants remained favorably inclined toward it. Several participants concluded that providing additional qualitative information on the Committee’s intentions regarding the federal funds rate after the unemployment threshold was reached could be more helpful. Such guidance could indicate the range of information that the Committee would consider in evaluating when it would be appropriate to raise the federal funds rate. Alternatively, the policy statement could indicate that even after the first increase in the federal funds rate target, the Committee anticipated keeping the rate below its longer-run equilibrium value for some time, as economic headwinds were likely to diminish only slowly. Other factors besides those headwinds were also mentioned as possibly providing a rationale for maintaining a low trajectory for the federal funds rate, including following through on a commitment to support the economy by maintaining more-accommodative policy for longer. These or other modifications to the forward guidance for the federal funds rate could be implemented in the future, either to improve clarity or to add to policy accommodation, perhaps in conjunction with a reduction in the pace of asset purchases as part of a rebalancing of the Committee’s tools.
Participants also discussed a range of possible actions that could be considered if the Committee wished to signal its intention to keep short-term rates low or reinforce the forward guidance on the federal funds rate. For example, most participants thought that a reduction by the Board of Governors in the interest rate paid on excess reserves could be worth considering at some stage, although the benefits of such a step were generally seen as likely to be small except possibly as a signal of policy intentions. By contrast, participants expressed a range of concerns about using open market operations aimed at affecting the expected path of short-term interest rates, such as a standing purchase facility for shorter-term Treasury securities or the provision of term funding through repurchase agreements. Among the concerns voiced was that such operations would inhibit price discovery and remove valuable sources of market information; in addition, such operations might be difficult to explain to the public, complicate the Committee’s communications, and appear inconsistent with the economic thresholds for the federal funds rate. Nevertheless, a number of participants noted that such operations were worthy of further study or saw them as potentially helpful in some circumstances.
At the end of the discussion, participants agreed that it would be helpful to continue reviewing these issues of longer-run policy strategy at upcoming meetings. No decisions on the substance were taken, and participants generally noted the usefulness of planning for various contingencies.
After reading this, one wonders whether there will not always be something which works against tapering of Fed purchases.
Source: Federal Reserve