At its December meeting, the Fed decided to introduce thresholds for unemployment and inflation that should be reached before key interest rate hikes may be considered. According to our forecasts, the unemployment threshold of 6.5 per cent will not be reached until early 2015. Since inflation will not pose any obstacles either, the Fed will not hike its key rate until the spring of 2015. This forecast is also compatible with our estimated Taylor rules, which underscore the need for continued ultra-loose monetary policy.
The next step towards greater monetary policy transparency and understanding of the central bank’s reaction function is for the Fed to also introduce thresholds for its bond purchases (quantitative easing). This issue was discussed late last year, but a decision was postponed. We believe that such a decision may be approved later this spring and that bond purchases will continue as long as unemployment exceeds, say, 7 per cent, provided that inflation is under control. This implies a continued expansion in the Fed’s balance sheet into early 2014. After publication of the December 2012 meeting minutes, which discussed ending bond purchases as early as 2013, market expectations swung in a more hawkish direction. Recently, however, Fed monetary policy committee members, including Chairman Ben Bernanke, have underscored the importance of continued monetary stimulus measures.
With respect to the policy meeting that is now underway and will conclude tomorrow, we do not expect any changes to the pace of bond purchases or to the forward guidance. Q4 GDP will be released tomorrow and in all likelihood it will show that growth was soft late last year. That being said, reflecting a relatively strong holiday shopping season private consumption held firm in Q4. Looking ahead, the social security tax hike that arose as a result of the year-end federal budget agreement will have a powerful, but temporary effect on disposable income. As a result, consumption growth will be weak early in 2013 according to our forecast. Meanwhile data on housing has been better while labour market trends have been stable the drop in initial claims aside. All said, only minor changes are warranted in the statement in our view.
SEB