Sunday, March 16, 2014

FOMC Preview: More Tapering, Change to Guidance

by Calculated Risk on 3/16/2014 10:26:00 AM

Fed Chair Janet Yellen will chair her first FOMC meeting this week on Tuesday and Wednesday, and hold her first post-FOMC press conference following the meeting. It appears the FOMC will reduce monthly asset purchases by another $10 billion per month, from $65 billion to $55 billion. The weaker than expected recent data will probably not derail another round of tapering, and the focus this month will be on the change to the forward guidance.

From Goldman Sachs economist Sven Jari Stehn: March FOMC Preview: All about Guidance

[W]ill the Committee’s forward guidance change? The January minutes revealed disagreement within the Committee about the future direction of its forward guidance, with “some” favoring additional quantitative guidance and “others” preferring a switch to qualitative form of guidance. Since then, however, both President Dudley and President Evans have argued in favor of qualitative guidance and we expect the Committee to move into this direction. We see two options for doing so.

The first would be to split the current guidance paragraph into two: one that reaffirms policy intentions above 6.5% and one that describes policy intentions below 6.5% in qualitative terms. For example, the Committee could state: “although the unemployment rate is approaching 6-1/2 percent, the Committee judges that employment remains well below its maximum sustainable level. Once the unemployment rate has declined below 6-1/2 percent, the Committee therefore intends to maintain the current exceptionally low target range for the federal funds rate of 0 to 1/4 percent as long as employment or inflation remain well below their longer-run goals.” Once the unemployment rate has fallen below 6.5% they could simply delete the “6.5%” paragraph and be left with a qualitative description of their intentions. This approach would follow the Bank of England’s approach which simply added a paragraph to their guidance statement that describes policy intentions after the threshold (in their case 7%) has been reached, but kept the original threshold statement.

The second option would be for the Committee to switch entirely to qualitative guidance and drop the 6.5% threshold at next week’s meeting. For example, Fed officials could simply state that “the Committee intends to maintain the current exceptionally low target range for the federal funds rate of 0 to 1/4 percent as long as employment or inflation remain well below their longer-run goals.” The FOMC could then follow the Bank of England in providing additional color on the Committee’s view on how far away the economy currently is from full employment and price stability. While the Bank of England published a separate document providing those details, Fed officials could include this information in Yellen’s prepared remarks at the start of the press conference.

Either option is possible in our view.
It will also be interesting to see if there are any changes to the FOMC projections. I expect any change to be minor.

For review, here are the previous projections.   Several FOMC members have blamed the recent weak economic data on the severe winter weather, so any downward revision to the 2014 GDP projections will probably be small.

GDP projections of Federal Reserve Governors and Reserve Bank presidents
Change in Real GDP12013201420152016
Dec 2013 Meeting Projections2.2 to 2.32.8 to 3.23.0 to 3.42.5 to 3.2
Sept 2013 Meeting Projections2.0 to 2.32.9 to 3.13.0 to 3.52.5 to 3.3
1 Projections of change in real GDP and inflation are from the fourth quarter of the previous year to the fourth quarter of the year indicated.

The unemployment rate was at 6.7% in February. 

Unemployment projections of Federal Reserve Governors and Reserve Bank presidents
Unemployment Rate22013201420152016
Dec 2013 Meeting Projections7.0 to 7.16.3 to 6.65.8 to 6.15.3 to 5.8
Sept 2013 Meeting Projections7.1 to 7.36.4 to 6.85.9 to 6.25.4 to 5.9
2 Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated.

As of January, PCE inflation was up 1.2% from January 2012, and core inflation was up 1.1%.  The FOMC expects inflation to increase in 2014, but remain below their 2% target (Note: the FOMC target is symmetrical around 2%, so this is about the same miss as 2.9% inflation). 

Inflation projections of Federal Reserve Governors and Reserve Bank presidents
PCE Inflation12013201420152016
Dec 2013 Meeting Projections0.9 to 1.01.4 to 1.61.5 to 2.01.7 to 2.0
Sept 2013 Meeting Projections1.1 to 1.21.3 to 1.81.6 to 2.01.7 to 2.0

Here are the FOMC's recent core inflation projections:

Core Inflation projections of Federal Reserve Governors and Reserve Bank presidents
Core Inflation12013201420152016
Dec 2013 Meeting Projections1.1 to 1.21.4 to 1.61.6 to 2.01.8 to 2.0
Sept 2013 Meeting Projections1.2 to 1.31.5 to 1.71.7 to 2.01.9 to 2.0