The US Federal Reserve begins a new phase of Forward Guidance

Today I wish to travel across the Atlantic to New York and review what we learnt from the decisions of the US Federal Open Markets Committee yesterday evening. In particular I will look at what I think they plan to do next. But first let us examine what decisions were made. From the FOMC statement.

 the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate.

Actually of course a real sign of the times was that no change was expected in ordinary monetary policy but changes were expected in extraordinary monetary policy. Accordingly for once we can use the phrase as expected for the announcement below.

Accordingly, the Committee decided to conclude its asset purchase program this month.

Is this the end for what has become called QE3?

Not as definitively as much of the media would have you believe. What we can say is the main monthly flow of purchases is now concluded but there are still “Operation Twist” style elements going on just like the Bank of England.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.

So we have a minor flow element remaining ( it is not also a sign of the times that what are large numbers seem minor?). We also have a large stock element because the US FOMC intends to keep its balance sheet constant at its current inflated level. As I type this some 4.48 trillion US Dollars of assets sit on its balance sheet meaning that someone somewhere has 4.48 trillion US Dollars of liquidity in case you were wondering why asset prices are so inflated in so many areas. I was involved in a debate yesterday about whether this matters and have to confess I am somewhat bemused by the case saying it does not. You may not care about what the FOMC holds but someone somewhere has the cash/liquidity and is presumably using it which has consequences. As it happens the FOMC agrees.

This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

Is this it for new purchases?

If it is it will be thrid time lucky as we have been told this twice before hence the name QE3. I have to confess I had a wry smile at this announcement from James Rickards.

Elapsed time from end of to start of was 17 months. Time between and was 15 months. So, expect in late 2015.


Is this it for QE?

Those proclaiming this seem to have forgotten the samuri like enthusiasm of the Bank of Japan for this as it buys up Yen denominated assets. Also those waiting for the European Central Bank to start seem to have missed the fact that it has! The covered bond purchases of the ECB totalled some 1.7 billion Euros last week.Oh and those who recall my update of Ghana will remember that its central bank went so far as direct monetisation earlier this year.

Hawkish policy hints

There were some of this in the FOMC statement.

The Committee judges that there has been a substantial improvement in the outlook for the labor market since the inception of its current asset purchase program.

So we are moving away from phrases like “considerable slack” which have been replaced by this.

Labor market conditions improved somewhat further, with solid job gains and a lower unemployment rate. On balance, a range of labor market indicators suggests that underutilization of labor resources is gradually diminishing.


if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated

If we are looking for a market response to this then we saw currency markets push the US Dollar higher. The UK Pound was pushed down below US $1.60 and it was one of the better performers. Of course the ECB will welcome the Euro falling below 1.26 versus the US Dollar in the same way that the BoJ will welcome the Yen pushing towards 109. As the US Dollar is the world’s major reserve currency (and most commodities are priced in it) there are smaller effects on the US from a currency appreciation than elsewhere especially if we factor in that relative to the UK for example its level of foreign trade is much lower.

Okay what about dovish hints?

This comes from the area of inflation as shown below.

Inflation has continued to run below the Committee’s longer-run objective. Market-based measures of inflation compensation have declined somewhat;

Now you can argue about how much emphasis the US FOMC actually places on inflation and targeting it. But it is below target and with oil prices where they currently are it seems set be under downwards pressure even before we factor in the fact that the QE which has now seen monthly additions end was supposed to boost inflation.

Also this was retained.

The Committee anticipates, based on its current assessment, that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program.

The new phase of Forward Guidance

This was most demonstrated by Bank of England Governor Mark Carney in his Mansion House speech back in June.

There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced.
It could happen sooner than markets currently expect.

This is part of the new strategy of promising interest-rate rises without actually delivering on them. The gains from such a move are duofold. Firstly official rates do not actually change so one remains in a ZIRP (Zero Interest Rate Policy) environment that those in ivory towers love so much. Secondly market expectations will change such as future interest-rate expectations and the currency is likely to rise. So in a theoretical ivory tower world one can get the best of both! Sadly reality is unlikely to be so convenient as the two elements do clash but as PM Dawn wisely observed for some.

Reality used to be a friend of mine.
Reality used to be a friend of mine
Please don’t ask me ’cause I don’t know why,
but reality used to be a friend of mine.

In my opinion the US FOMC is moving into such a scenario where it will promise something and deliver nothing. On such a road then hints of interest-rate rises will follow Carly Simon

But if you’re willin’ to play the game
It will be comin’ around again.

I guess Status Quo fans will be thinking of “Again,Again” here. But maybe Kate Bush had it right as central bankers would if only they “could”

If I only could
Be running up that hill
With no problems…

There are of course differences in the circumstances of the UK and US. The major one is that the recent path of real wages is better in the US and please do not misunderstand me as I wrote better and not good. But there are lot of similarities as we consider if central bankers are the equivalent of Status Quo and keep playing the same chords.


15 thoughts on “The US Federal Reserve begins a new phase of Forward Guidance

    • Hi Forbin

      I think that Alan Greenspan’s days of being considered an economic guru are well behind him! If they were not already in such a place predicting that gold will rally in front of a sharp price drop post-FOMC (US $1198.9 as I type this) might have damaged it.

      Of course we are left with a problem these days which is whether he is actually intending to offer us sound advice?

      It has been another ropey day for oil prices too as the price of a barrel of Brent Crude Oil falls back below US $86.

    • He may be referring to the Swiss “Save our Swiss gold” referendum in Switzerland due November 30th if memory serves.

      If the vote is yes then the SNB will be required to hold at least 20% of it’s assets in gold which with all that defending of the Swissy, it’s balance sheet must be ginormous which will then have to be “balanced” by 20% holdings in gold. Personally, if the referendum succeeds, I see the SNB gold purchases going off the richter scale and presumably they daren’t print more francs to buy it with as they will have increased their balance sheet again, requiring more gold purchases, thereby imitating a dog chasing it’s tail.

      No, it’s more likely they will use that stash of foreign currency they’ve accumulated defending the Swissy. So with the SNB possibly trampling around in gold and FX markets in a month or so Greenspan may be right – go long gold and short the Euro, which should help the EZ problems when combined with their current respectable money supply growth.

      • Forgot to say if the SNB follow the action outlined above the Swissy will of course probably strengthen which is against another of their policies so they will find themselves between a rock and a hard place.

    • Hi Benfitzg

      Thank you. As to what they will do as I said in the piece I think that they are much further away from a rate increase than many think especially if you consider the changes that happen next year in the composition of the FOMC.

      Also in today’s GDP report I note that the deflator fell to 1.3% and the core deflator to 1.5% so there is still disinflationary pressure around. This only reinforces my views.

      Meanwhile should we get a weak equity market and a slowing of the economy I think that they would respond very quickly.

  1. Hi Shaun
    You read the US shadow stats, so you know the reality of the ‘unemployment’ numbers. Highest non-participation for 30 years at least, so ‘low’ official unemployment. Highest increase in ’employed’ numbers in the OAP group, mainly part-time of course. Obamacare costs have dramatically increased the incentive for employers to hire part-time and escape the burden which then lies with the State.
    The US ‘property bubble’ a la 2008 hasn’t gone away, despite 30/40% falls in prices immediately after the crisis. Its just morphed into ‘rental’ properties held by PE companies. The FED dare not increase rates as this would explode , but had to close off more QE to stop the new bubble getting bigger. I doubt QE4 will happen.
    The more I am in the States and understand how their social security and Obamacare works the more I am struck by how very similar it is to the UK. Almost all OAPs get social payments, not called state pensions, but its exactly the same, with exactly the same funding problems. Health care costs are now almost identical to NI contributions for the same salary.
    The UK might be ‘in’ the EU, but for most practical purposes it is ‘airstrip one’!

    • Hi JW

      Just simple maths makes one wonder where all the people have gone as the participation rate change comes to around 10 million of them?

      The Financial Times sees today’s GDP figures as showing “vigour” and there are elements of truth in that but as you say there are also plenty of questions about what is really going on. So we have some successes but certainly no escape velocity yet.

        • Of course! I kept thinking of Private Enterprise and Price Earnings, this may be the beginning of senility! The site seems to be preventing me from replying directly to your question to me re how does the Swiss Franc fix to the Euro at 1.20 work with my outline so I’m replying here:

          It doesn’t work, that’s why I say the SNB will find itself between a rock and a hard place if the referendum is “yes”. In other words the saving of Swiss gold ids incompatible with the Euro/CHF stability peg.

          The only thing I can see for SNB to do in such a situation is buy lots of Euros to defend the peg, in the process expanding it’s balance sheet thereby requiring it to buy more gold to keep the “20%” peg. Of course, the more Euros they buy the more gold they have buy and they mimic a dog chasing it’s tail. This is obviously unsustainable but they may give it a good go before admitting defeat. So if you’re long gold as Greenspan recommends then you could do quite nicely. Alternatively, if SNB abandon’s it’s CHF/Euro peg to pursue gold holdings then anyone long gold and short the Euro wins both ways whilst SNB loses both ways The “safe” bet would therefore appear to be long gold. .

        • Er and I see I still havent explained properly. All my thoughts are based on the assumption the SNB will buy Gold with the CHF thereby expanding it’s balance sheet. So it’s got to get rid of something to shrink the balance sheet otherwise it has to buy more and more gold to keep the 20% peg. and I assume that “something” would be foreign currency, with the Euro as the hot contender given that SNB has so many Euros. This could put pressure on the peg.

          The ECB is already doing a bit of QE but may decide/get the Germans to agree to doing serious QE which, along with current economic performance will encourage traders to sell Euro and will consequently weaken the Euro (much to Draghi’s delight).

          Now, SNB would be forced to buy masses of Euros to defend the Euro/CHF peg and as it’s balance sheet expands, once more, has to buy more gold, again.

          SNB may now decide to abandon the Euro/CHF peg as it has a legal mandate form the electorate to maintain 20% of it’s balance sheet in gold holdings but (as far as I know) no such mandate re the Euro/Chf peg and so the Euro falls rewarding those short the Euro against the CHF and long gold twice.

          If SNB refuses to abandon it’s Euro/CHF peg then it continues buying more and more Euros against the ECB’s QE and has to continue buying gold to achieve it’s mandatory 20% gold holding, until someone wakes up and demands the 20% gold holding be abandoned. I think that wake up will be a long time coming and in the meantime those long gold will, as Greenspan suggests, do quite well.

  2. It seems the FOMC is already reducing QE – Monetary base now stands at $4 trillion, it was at $4.3 trillion in July thru beginning of September thereby demonstrating a flat line before falling to it’s current value.

    This has been achieved via it’s ongoing Reverse Repo program alongside it’s term deposit facility and it has just today announced that it intends to double it’s reverse repo operations beginning December presumably to reduce quarter end volatility in use of the program as Banks scramble for Fed holdings at each quarter end to make their balance sheets look good. In the first instance this is going to temporarily drain liquidity/QE from the system and the beauty of the Repo tool is that thru use of interest rates on the facility it can help leave liquidity higher. Currently, it looks like the Fed is happy to drain liquidity via the Repo and Term Deposit facility.

    So, to get a better idea of what the Fed is doing I suggest we need to watch their actions re Reverse Repo, Term Deposit Facility, QE (if any) and Fed Funds target rate. They have a series of tools they can use to finely tune different parts of the monetary base now and it is the interplay of ALL these tools which will reveal the true picture and future direction. base

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s