Fed Taper Message Succeeds as Bonds Adjust to Economic Data
After misleading investors with a time line for tapering its unprecedented stimulus, the Federal Reserve now is stressing that any reduction in bond purchases will depend on the economic outlook -- and the message is sinking in.
Officials surprised traders and roiled markets across the globe on Sept. 18 by maintaining their $85 billion in monthly asset purchases. Investors had clung to Chairman Ben S. Bernanke’s May guidance that he might taper “in the next few meetings” of the policy-making Federal Open Market Committee, ignoring the weakest back-to-back months for payroll gains in a year and a jobless rate that was falling partly because workers were leaving the labor force.
The Fed since then has emphasized that changes are “not on a preset course” and hinge on the economy. The result: When unemployment dropped to a five-year low of 7 percent in November, the odds doubled that the central bank would begin tapering its bond buying this week, a Bloomberg survey showed.
“A lot of people, including myself, are now looking at the data and saying, ‘Okay, if that’s the way they want to go,’” said John Silvia, chief economist at Wells Fargo Securities LLC in Charlotte, North Carolina. Before September, “all of this talk about tapering without the context of the numbers threw the market off.”
Fed Vice Chairman Janet Yellen, the nominee to replace Bernanke as chairman, told the Senate Banking Committee Nov. 14 that communications are “challenging” because the central bank is in “unprecedented circumstances.”
“So, it is a work in progress, and sometimes miscommunication is possible,” she said at her confirmation hearing in Washington.
The Fed’s unexpected decision on Sept. 18 to refrain from changing its policy sent stocks to record highs and triggered the biggest rally in Treasuries since 2011. The yield on the benchmark 10-year note fell 16 basis points, or 0.16 percent, that day to 2.69 percent and continued to drop, reaching 2.5 percent on Oct. 23, according to Bloomberg Bond Trader prices.
With recent data showing continued improvement in the U.S. economy, yields have climbed, hitting 2.88 percent on Dec. 12 after a larger-than-forecast jump in U.S. retail sales for November. This followed a Dec. 6 Labor Department report that payrolls swelled by 203,000 after a revised 200,000 increase in October. The November gain exceeded the 185,000 median forecast of 89 economists surveyed by Bloomberg.
The week of the jobs numbers, the Bank of America Merrill Lynch MOVE index, a gauge of Treasuries volatility, reached 76.1, the highest since Oct. 11.
The Fed has said it will keep buying assets “until the outlook for the labor market has improved substantially,” so the payroll data, along with the retail sales numbers, have bolstered speculation Bernanke will announce a reduction in quantitative easing at this week’s FOMC meeting on Dec. 17-18.
The share of economists forecasting such a move rose to 34 percent in a Bloomberg survey conducted the day of the jobs report from 17 percent on Nov. 8. Fifty-three percent predicted last month that tapering would begin in March, compared with 40 percent this month.
Bill Gross, co-chief investment officer at Pacific Investment Management Co., said Dec. 6 that the pace of payroll growth in November made the probability of a taper on Dec. 18 “at least 50-50 now” after he previously saw “some logic for a January starting point.”
Stocks rose today after Fed data showed U.S. industrial production increased 1.1 percent in November, the most in a year and more than the 0.6 percent gain forecast in a Bloomberg survey. The Standard & Poor’s 500 Index climbed 0.8 percent to 1,789.31 at 10:27 a.m. in New York.
Silvia predicts the Fed won’t taper until March or June, depending on the economy. One challenge the U.S. central bank will face is how to square their so-called data dependency with inflation that’s running below their 2 percent target, he said. Prices are accelerating at a 0.7 percent annual rate, the personal-consumption-expenditures price index showed in October.
Federal Reserve Bank of New York President William C. Dudley said it’s “not disturbing” if interest rates rise because the economic outlook is improving. If financial conditions tighten because markets have an “unrealistic view” of the outlook for monetary policy -- as happened between May and September -- that is concerning, he said at a Nov. 20 press briefing at the district bank.
“It’s important that people get our message broadly right,” Dudley said. If the market moves “inappropriately,” it’s more difficult for the Fed to achieve its goals.
Leading up to the September meeting, investors put less emphasis on the economic outlook because Fed officials were communicating concern about rising costs associated with their bond buying and “froth” in markets, according to Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut.
Bernanke said May 22 in Washington that policy makers were “quite aware of this issue and watching it very carefully.” It does “factor into our thinking about the appropriate amount of accommodation,” and the Fed could “take a step down in our pace of purchases” in the “next few meetings.”
The rise in interest rates that occurred from May to September wasn’t entirely unwelcome. “To the extent that some of the riskier, more levered positions have been eliminated, I think that makes the situation more sustainable,” Bernanke said Sept. 18 after the surprise decision not to taper.
“It wasn’t that the economic conditions had changed; the markets were perceiving that Fed officials were seeing the bubble-like conditions they were causing,” Stanley said. Policy makers have “gone back to where they were earlier in the year where it’s just about the economy.”
Bernanke defended his communications on Nov. 19, saying the September FOMC decision was “appropriate and fully consistent with the earlier guidance.” While he’d said in June the central bank might trim its purchases this year and halt them altogether by mid-2014, he had “also emphasized that the path of purchases would depend on incoming data and could be slower or faster than envisioned,” he said in a speech. “I noted that the pace of purchases could be increased for a time, if warranted.”
Policy makers’ efforts to underscore the link between economic data and the level of monetary accommodation makes it unlikely the Fed will adopt a proposal to accompany any tapering decision with a timetable, according to Silvia. Atlanta Fed President Dennis Lockhart, Dallas Fed President Richard Fisher and Charles Plosser of Philadelphia -- none of whom vote on policy this year -- all have endorsed the idea of a schedule.
“If you’re going to say you’re data-dependent, then to give me a calendar -- you’re going to have trouble,” Silvia said. “Stop being so specific. You don’t have everything under control, then you over-promise and under-deliver.”
The Dec. 6 jobs report prompted Ward McCarthy, chief financial economist at Jefferies LLC in New York, to forecast a “gentle” taper of $5 billion a month starting in December. McCarthy had correctly predicted the FOMC would maintain the pace of its quantitative easing in September, though he wondered in a note to clients at the time if he was “putting too much emphasis on current economic conditions.”
The “data really does argue for them to do something,” McCarthy said in Dec. 6 interview on Bloomberg Radio. “The unemployment rate is within half a percentage point of a level that at one time they told us would trigger raising rates, and they haven’t even started tapering yet.”
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