Sunday, December 15, 2013

FOMC Projections Preview: To Taper, or Not to Taper

by Bill McBride on 12/15/2013 11:11:00 AM

The FOMC meets on Tuesday and Wednesday of this week.  It seems some modest "tapering" of monthly asset purchases is possible, although the consensus is the Fed will wait until January or March of next year.

Here is some analysis, first from Merrill Lynch:

Once again, market anticipation is rising ahead of a Fed meeting. In our view, this meeting will be defined by what the Fed doesn’t do: we see a low chance of the start to tapering or meaningful changes to forward guidance. Rather, we look to Chairman Bernanke’s final press conference for a broad discussion of Fed policy options into next year. He is likely to signal both that tapering could start early next year — conditional on the data — and that the Fed will be patient and gradual as it winds down its purchase program. We also expect him to indicate that the Fed will strengthen its forward guidance if needed, but keep his options open. The overall tone should be modestly dovish, especially relative to market expectations of potential start to tapering. We expect him to reiterate that the Fed intends to keep policy accommodative well into the future in order to support a broader and more sustained recovery.
And from economist David Mericle at Goldman Sachs:
Fed officials face a more difficult decision at their meeting next week, as the employment and growth data have picked up since the October meeting. But our central forecast for the first tapering move remains March, with January possible as well. We see a decision to taper next week as unlikely for three reasons.

First, the case for tapering on the basis of the data since October is mixed at best. The strongest argument in favor is the improvement in the trend rate of payroll growth to the 200k level. However, we expect that Fed officials will also put considerable weight on inflation, which has fallen further in recent months. At current spot and projected inflation rates, a tightening move would be quite unusual by historical standards.

Second, we continue to expect that tapering will be offset by a strengthening of the forward guidance, but we doubt the FOMC is ready to take this step. While some eventual strengthening or clarifying of the forward guidance is now a consensus expectation, the October minutes and recent Fed commentary suggest little agreement on what form this should take.

Third, while consensus expectations now place greater probability on a December taper, it remains a minority view. We suspect that this makes a move less likely, as Fed officials will be reluctant to deliver a hawkish surprise that could tighten financial conditions and raise doubts about their commitment to the inflation target.
My view is the data is broadly consistent with the FOMC's projections in June and September.  Inflation is too low, but the FOMC was projecting low inflation - and they are expecting inflation to pick up in 2014.  Most analysts expect the FOMC to wait until 2014, but a small taper this week should not be a surprise.

If the Fed does reduce their asset purchases, the "taper" will probably be small - perhaps to $75 or $80 billion per month from the current $85 billion per month. If purchases are reduced, it seems likely that the Fed will continue to purchase agency mortgage-backed securities at the current rate ($40 billion per month), but reduce their purchases of longer-term Treasury securities from $45 billion per month.

In the press conference on Wednesday, I expect Fed Chairman Ben Bernanke will probably make it clear that the Fed will not raise rates for a "considerable" time after the end of QE, and it seems likely he will express more concern about the low level of inflation.

On the projections, it looks like GDP will be mostly unchanged, and the projections for the unemployment rate might be reduced, and PCE inflation will be reduced.  Note: I've included earlier projections to show the trend (TBA: To be announced). 

Early forecasts for Q4 are that real GDP will increase at around a 1.7% annual rate, and that would put 2013 real GDP growth at 2.2% or so - right in the FOMC's September range.   A key will be any changes to the 2014 GDP projections.

GDP projections of Federal Reserve Governors and Reserve Bank presidents
Change in Real GDP12013201420152016
Dec 2013 Meeting ProjectionsTBATBATBATBA
Sept 2013 Meeting Projections2.0 to 2.32.9 to 3.13.0 to 3.52.5 to 3.3
June 2013 Meeting Projections2.3 to 2.63.0 to 3.52.9 to 3.6  
Mar 2013 Meeting Projections2.3 to 2.82.9 to 3.42.9 to 3.7
1 Projections of change in real GDP and in inflation are from the fourth quarter of the previous year to the fourth quarter of the year indicated.

The unemployment rate was at 7.0% in November (and 7.3% in October) and the projections for the Q4 average might be revised down a little.

I also expect the FOMC to project lower unemployment rates in 2014 and 2015.

Unemployment projections of Federal Reserve Governors and Reserve Bank presidents
Unemployment Rate22013201420152016
Dec 2013 Meeting ProjectionsTBATBATBATBA
Sept 2013 Meeting Projections7.1 to 7.36.4 to 6.85.9 to 6.25.4 to 5.9
June 2013 Meeting Projections7.2 to 7.3 6.5 to 6.85.8 to 6.2
Mar 2013 Meeting Projections7.3 to 7.5 6.7 to 7.06.0 to 6.5
2 Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated.

Projections for inflation will probably be lower.  PCE inflation through October was only up 0.7%, although PCE inflation should be up a little more year-over-year in November and December (because prices declined in November and December last year).   I expect the FOMC to revised down 2013 inflation to 1.0% or so.

A key will be the FOMC's projections for inflation in 2014 and 2015.  If the FOMC thinks low inflation is transitory, they will be more willing to taper at this meeting.  If not - if they think low inflation will persist - then they will want to wait to reduce asset purchases

The current concern is that inflation is too low and well below the Fed's target.

Inflation projections of Federal Reserve Governors and Reserve Bank presidents
PCE Inflation12013201420152016
Dec 2013 Meeting ProjectionsTBATBATBATBA
Sept 2013 Meeting Projections1.1 to 1.21.3 to 1.81.6 to 2.01.7 to 2.0
June 2013 Meeting Projections0.8 to 1.21.4 to 2.01.6 to 2.0
Mar 2013 Meeting Projections1.3 to 1.71.5 to 2.01.7 to 2.0

Core inflation was up 1.1% year-over-year in October, and will probably be a little higher in November and December.  The FOMC might revise core inflation down slightly for 2013, but the key will be 2014.

Core Inflation projections of Federal Reserve Governors and Reserve Bank presidents
Core Inflation12013201420152016
Dec 2013 Meeting ProjectionsTBATBATBATBA
Sept 2013 Meeting Projections1.2 to 1.31.5 to 1.71.7 to 2.01.9 to 2.0
June 2013 Meeting Projections1.2 to 1.31.5 to 1.81.7 to 2.0
Mar 2013 Meeting Projections1.5 to 1.61.7 to 2.01.8 to 2.0

Conclusion: In September I wrote "It does seem odd that the FOMC would start reducing asset purchases while downgrading GDP, and also expressing concern about the downside risks from fiscal policy".    In some ways the reverse is true now.  GDP and unemployment will meet or exceed the FOMC's September projections, and core inflation will be close.  And fiscal policies appear resolved for 2014. 

Clearly the data is broadly consistent with the September FOMC projections, so a small taper should not be a surprise (even if most analysts think the FOMC will wait until early 2014).

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