FedWatch: From quantitative to qualitative
Next week’s meeting of Federal Reserve policymakers essentially can be boiled down to two questions: Will they continue to taper at the current $10 billion monthly pace? And will forward guidance on the target funds rate be adjusted given we’re closing in on the 6.5% unemployment-rate threshold the Fed has said could merit a move toward tightening? In our opinion—and to be honest, this pretty much is the market consensus—the answer to both questions is, “Yes.’’
There’s no doubt growth decelerated sharply toward the end of 2013 and into the first quarter, leading some to suggest the Fed may pare the pace of tapering—if not delay it outright—until the economy gets back on its feet. But recent testimony from new Fed Chair Janet Yellen and comments from other central bank officials suggest they, as we and many others, view the slowdown largely as a transitory consequence of one of the worst winters in modern history. While some lost sales and foregone activity may never be recovered, growth is expected to perk up as the crocuses start to bloom, with the economy getting back on the faster growth track it was traveling last fall. Yellen has testified it would take a notable change in this outlook to merit any changes in tapering’s current course, which is scheduled to bring an end to quantitative-easing asset purchases by early fall. In addition, January’s first reduction in the monthly purchases did not cause long-term interest rates to spike, suggesting to the Fed that the market already has priced in the size and pace of tapering.
One change that is anticipated is the elimination of the 6.5% unemployment-rate benchmark the Fed has cited for justifying a potential increase in the federal funds target rate. Given that many other metrics indicate the labor market continues to operate at well-below optimum levels, we believe the Fed will replace this quantitative forward guidance with qualitative guidance—that is, instead of a specific numeric threshold, it may say it will monitor a basket of indicators of labor-market health, such as wage growth, the labor-force participation rate and the broader U6 unemployment rate that accounts for the underemployed and discouraged workers. These measures continue to suggest a fair amount of slack and job-market weakness.
One final note: this Federal Open Market Committee (FOMC) meeting will mark Yellen’s inaugural appearance at a post-meeting press conference. These occur every other meeting and were initiated by former Chairman Ben Bernanke as part of the Fed’s move to be more transparent—a change for which Yellen advocated. In her testimony before Congress and other public appearances as Fed chair, Yellen to date has parroted Bernanke’s words and deeds. It will be interesting to see if she adds any new wrinkles that let her put her stamp on what is now her Fed.