The FOMC does not usually take the market by surprise but it did today. Contrary to our and the consensus expectations, the Fed maintains bond purchases at USD85bn. The Fed wants to see more evidence that the economy is gradually improving. The surprisingly dovish move gave strong and predictable market reactions – a weaker dollar and stronger stock markets.
Real GDP for 2013 and 2014 was revised lower; and the characterizations of economic activity and the labor market were somewhat less optimistic compared to the last statement. Moreover, mortgage rates have risen further while fiscal policy is restraining growth. Fiscal policy is actually cited in two places which is a subtle nod to the coming fight in Congress over the debt limit.
The reason the Fed gave not to taper was interesting. While acknowledging that the downside risks to the outlook have diminished, the tightening of financial conditions observed in months could slow the progress in the economy. But isn’t it a Catch-22 since financial conditions have tightened because markets thought that the Fed was going to taper? In any event, tapering too early was perceived as a bigger risk than tapering too late at the current juncture. Meanwhile, the guidance on interest rates remained unchanged; the Fed expects rates to stay near-zero at least as long as the unemployment rate remains above the 6.5 per cent threshold.
Judging when to moderate asset purchases, the Committee will assess whether incoming information continues to support the expectation of ongoing improvement. Previously, the Committee was prepared to either “increase or reduce” the pace of asset purchases. What this is suggesting is that the Fed is willing to reduce the pace of asset purchases soon (read the December meeting) which is consistent with what Bernanke said in June. Indeed, at the press conference Bernanke said that the basic principle is still in place. But the Feds economic outlook – when taking the extent of federal fiscal retrenchment into account, the Committee sees economic activity as consistent with growing underlying strength – needs to be confirmed.
The decision was supported by all but one member, Esther George. She is still worried about inflation and financial stability and has dissented at each meeting in 2013.
Economic forecasts
The unemployment rate is expected at 7.2 per cent by the fourth quarter 2013 and 6.6 per cent by the fourth quarter of 2014, slightly lower compared to previous forecasts. Real GDP growth was shaved quite substantially however, to 2.15 per cent by the fourth quarter 2013 and to 3 per cent by the fourth quarter of 2014.
With respect to interest rate projections, ten of 17 Fed officials see the fed funds rate at or below 2 per cent by the fourth quarter of 2016. Moreover, 14 of 17 don’t see the Fed raising rates until 2015 or 2016. The longer-run range for the fed funds rate is 3.25-4.25 per cent.
SEB