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.
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.