While we still await Jan Hatzius to lower his full year outlook any second now, to keep in line with Bernanke's drastic growth outlook reduction from yesterday's press conference, here is Goldman's Sven Stehn sharing his interpretation of the Fed's "color" from yesterday. The conclusion: "Taken together, Bernanke’s remarks were consistent with our forecast for no rate hikes for a long time to come." And we would go further: just as in 2010, which 2011 has so far been an identical replica of, the second there is a 15% drop in the Russell 2000 (which hit a new all time high yesterday) following the end of the liquidity pump, "economic conditions" will deteriorate, necessitating another loosening episode. And it will come - sooner or later.
- We believe Chairman Bernanke would have good reason to be pleased with his first press conference. We see three main takeaways from today’s events. First, the Committee downgraded its growth outlook modestly. Although “very weak” construction activity and high gasoline prices played a role, Bernanke indicated that most of this downgrade was due to “transitory” weakness in the first quarter.
- Second, the Committee pushed up its projections for headline and core PCE inflation. However, Bernanke suggested that higher commodity prices “account for pretty much all” of the increase in inflation forecasts over the short term. Bernanke reiterated that inflation expectations have so far remained stable but also reminded market participants that he sees “no substitute for action” should inflation expectations rise notably going forward.
- Finally, the Committee decided that QE2 will be concluded on schedule at the end of June and Bernanke indicated that reinvestment of maturing securities would continue thereafter. Less clear was Bernanke's statement that “extended period suggests it would be a couple of meetings probably before action.” This was somewhat of a surprise, because we had long thought that the guidance language meant to signal no rate hikes for a somewhat longer period—three to four meetings at least.
- Taken together, Bernanke’s remarks were consistent with our forecast for no rate hikes for a long time to come.
Full note from Goldman's Sven Jari Stehn
Today marked a watershed in Fed communication. After release of the Federal Open Market Committee (FOMC) statement at 12:30pm, Chairman Bernanke gave his first post-meeting press conference at 2:15pm in which he presented the FOMC’s economic forecasts and then took questions from journalists. We believe Bernanke would have good reason to be pleased with his first press conference.
In the remainder of this comment we summarize the main takeaways from today’s events.
1. A modest downgrade to the growth outlook, mainly due to transitory first-quarter weakness.
As expected in light of recent information, the FOMC shaved its real GDP growth numbers and described the recovery as "proceeding at a moderate pace". Specifically, the FOMC’s “central tendency” range (which excludes the three most extreme projections on each side) for 2011 real GDP growth was reduced from 3.4-3.9% in January to 3.1%-3.3% (see Exhibit below). Expectations for growth in 2012 and 2013 were cut very slightly as well. At the same time, the Committee upgraded its assessment of the labor market. In particular, projections for the average unemployment rate in 2011Q4 were cut significantly to 8.4%-8.7% from 8.8%-9.0% previously. The top end of the 2012 range was lowered slightly as well, whereas the 2013 range remained unchanged.
Chairman Bernanke then provided a lot of helpful context to understanding this outlook in his remarks during the press conference. He revealed that he expects first-quarter growth of “a little under 2%”. However, he stressed that most of the slowdown in the first quarter is “transitory,” as it was driven by “lower defense spending than anticipated”, “weaker exports” and “other factors, like weather”. Chairman Bernanke furthermore offered a couple of reasons for taking down growth in the remainder of 2011. First, he highlighted “very weak” construction activity, both residential and nonresidential. Second, he acknowledged that rising gas prices create “financial hardship” for households by subtracting from household income, thus making “economic developments less favorable.”
With regard to risks to the Committee’s growth outlook, Bernanke acknowledged that forecast uncertainty remains high. In particular, he sees downside risks to growth from developments abroad—including from the Middle East and Japan. Although Bernanke regards fiscal consolidation as a “top priority,” the budget cuts that have been made so far don't appear to have had “significant consequences for short-term economic activity.”
2. Slightly higher inflation, chiefly due to rising commodity prices.
In an acknowledgement that "inflation has picked up in recent months," the Committee pushed up its projections for headline and core PCE inflation. Expectations for 2011 headline inflation were raised to 2.1%-2.8% (versus 1.3%-1.7% previously), but headline projections for 2012 and 2013 were anticipated to be broadly the same as before. Core inflation projections were lifted by 0.3 percentage points in both 2011 and 2012, but remain below the Committee’s “mandate-consistent” level throughout the forecasting period.
Again, Chairman Bernanke provided helpful color on these numbers. First, he indicated that higher commodity prices “account for pretty much all” of the increase in inflation forecasts over the short-term. (It’s not clear, however, whether he meant that the 0.3 percentage point increase in the core inflation ranges primarily reflects commodity price pass-through, or simply the mechanical observation that the headline inflation projections have increased by far more than the core inflation projections.) Second, he stressed the importance of inflation expectations. He reiterated during the press conference that “it's fair to say that medium term expectations have not moved very much, and they still indicate confidence that the Fed will ensure that inflation in the medium term will be close to what I called the mandate-consistent level.” But he also reminded market participants that he sees “no substitute for action” should inflation expectations rise notably going forward.
3. No major changes to the policy outlook.
As widely expected, the Committee indicated that QE2 will be concluded on schedule at the end of June. Bernanke provided a number of additional insights during the press conference. First, he argued that the conclusion of QE2 at the end of June is unlikely to have significant effects for financial markets because the “stock” effect of the Fed’s security holdings is far more important than the “flow” effect of actual purchases. (Our own work supports this argument, see Sven Jari Stehn, “Stocks vs. Flows Revisited: End of QE2 Unlikely To Have Significant Effect on Bond Yields,” US Daily, April 13, 2011.) Second, he indicated that the Committee will continue to reinvest maturing securities past the end of QE in June. In particular he views ending reinvestment as “tightening” and, therefore, argued that ending reinvestment would represent an “early” step in the eventual exit process. Less clear was his response to a question on how to interpret the “extended period” language. He said that “extended period suggests it would be a couple of meetings probably before action”. This was somewhat of a surprise and would benefit from clarification, because we had long thought that the guidance language meant to signal no rate hikes for a somewhat longer period—three to four meetings at least. Finally, Bernanke was asked why the FOMC did not pursue additional asset purchases to stimulate the economy. He argued that the trade-offs were becoming less attractive, citing the higher levels of inflation and inflation expectations and suggesting it was less clear that additional purchases could stimulate job growth without raising inflation risks.
Taken together, Bernanke’s remarks were consistent with our forecast for no rate hikes for a long time to come.