WHEN
Wednesday 19 June 2013
19:00 BST: US FOMC rate decision (Jun)
19:00 BST: US Federal Reserve to release summary of economic projections
19:30 BST: Press conference with Fed chairman Ben Bernanke
WILL THE TAPERING DEBATE BE SETTLED IN JUNE?
Since Bernanke’s testimony to congress on 22 May markets have become jittery, and volatility has returned with a vengeance as traders try to price in the Fed’s tapering of its asset purchases.
The uncertainty is engulfing not only the US, but all financial markets, with emerging markets particularly bearing the brunt of the market’s wrath. And news from the US is likely to continue shaping traders’ focus in the weeks ahead.
The truth is that the market does not know what to expect from the Fed on this outing. The minutes from the previous Fed meeting in April showed that there is still a divergence of views on the FOMC. And some policymakers have been making comments that add to the uncertainty.
For example, St. Louis Fed president James Bullard – a hawkish voting member on the FOMC – recently said “labour market conditions have improved since last summer… [but] surprisingly low inflation readings may mean that the [FOMC] can maintain its aggressive programme over a longer time frame.” On the other hand, Bernanke’s now notorious comments at his congressional testimony seem more neutral, saying that the pace of asset purchases depends on incoming economic data.
Analysts at Rabobank point out that economic data has been mixed as of late. “While the economic fundamentals in the US have improved, the recovery is being restrained by a global growth slowdown and domestic fiscal policy uncertainty. As a result, the data are not uniformly good, nor are they uniformly bad,” which, in the context of Bernanke’s comments, may suggest that tapering isn’t imminent.
The IMF has also waded into the tapering debate. In its annual review of the US economy, the organisation urged the Fed to keep its current pace of QE in place until the end of year, exhorting the Fed to “carefully calibrate” the timing of its exit from QE.
And while some traders anticipate the Fed to scale back its programme of quantitative easing before the end of 2013 – the Wall Street Journal’s influential Fed watcher, Jon Hilsenrath, also reminded us in an article that the Fed is unlikely to go cold turkey, switch off the monetary taps and raise rates immediately.
It is important to note that the focus of Hilsenrath’s article was about when the Fed was likely to start lifting interest rates. The market, however, seems to be more concerned about when the Fed will scale back asset purchases – but the two are different.
In the article, Hilsenrath writes “chatter about pulling back the bond program has pushed up a wide range of interest rates and appears to have investors second-guessing the Fed’s broader commitment to keeping rates low. This is exactly what the Fed doesn’t want. Officials see bond buying as added fuel they are providing to a limp economy. Once the economy is strong enough to live without the added fuel, they still expect to keep rates low to ensure the economy keeps moving forward.”
Hilsenrath also believes that Bernanke will be pushing home the point that there will be “considerable” time between ending bond buying and raising rates in his press conference. It is an argument that Societe Generale’s Kit Juckes also supports: “The general expectation is that the Ben Bernanke will calm fears of over-zealous ‘tapering'. Still, the case for beginning the process of letting some air out of the monetary bubble is pretty clear, and surely the Fed will be wary of backing down too easily.”
However, others opine that the Fed will be explicit in its intention to taper QE soon. The FT’s Washington correspondent Robin Harding this week wrote an article suggesting that the Fed is likely to signal tapering is close. “Markets seem reluctant to acknowledge the improvement that is leading the Fed towards a taper of QE3. But they also appear to be assuming, incorrectly, that any taper means the Fed has become less willing to support the economy’s recovery.”
Harding adds “Bernanke is likely to push against both misponceptions, combining an upbeat message on how the strength of the economy will soon justify a taper, with a signal that further tapering depends on further improvement in the economy and in no way brings forward an interest rate rise,” which is similar to the Hilsenrath line.
NEW ECONOMIC PROJECTIONS
The Fed’s previous economic forecasts predicted that the US economy would grow by 2.6% in 2013 and 3.2% in 2014 (read the previous projections here). And the Fed also predicts that unemployment will fall from 7.4% in 2013 to 6.9% in 2014. “In every year of the economic recovery the Federal Reserve has overestimated how fast the economy would grow,” writes Hilsenrath, in another article this week.
Nevertheless, Jim Reid, a strategist at Deutsche Bank, says that the key takeaway from Wednesday’s FOMC releases could be how these projections have changed. He says “if and how these forecasts change could send an important signal about the Fed’s near-term intentions,” adding “if the Fed maintains confidence in their economic forecasts, it could signal they think they're on track to begin pulling back on QE later this year.”
Hilsenrath himself argues that “Fed officials have been talking lately as if they still think that a growth pickup could happen, which suggests they won't be making big changes to their forecasts.”
Also important, however, is where the Fed sees inflation. Mansoor Mohi-uddin, a strategist at UBS, noted “that remains the key risk from the FOMC meeting in the week ahead. But as investors have already been cautioned to expect a dovish press conference from Bernanke, we think any downside to the dollar here is already largely priced. Instead, we expect investors will look through attempts to push back rate hike expectations and focus still on when the Fed will slow down its asset purchases.”
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