Goldman Forecasts Fed Will Lower Rate-Hike Threshold In December To Counter Taper Tantrum

Tyler Durden's picture

The extreme experiment of current US monetary policy has evolved (as we noted yesterday), from explicit end-dates, to unlimited end-dates, to threshold-based end-dates. Of course, this 'threshold' was no problem for the liquidty whores when unemployment rates were extremely high themselves, but as the world awoke to what we have been pointing out - that it's all a mirage of collapsing participation rates - the FOMC (and sell-side strategists) realized that the endgame may be 'too close'. Cue Goldman's Jan Hatzius, who in today's note, citing two influential Fed staff economists, shifts the base case and forecasts that the Fed will lower its threshold for rate hikes to 6.0% (and perhaps as low as 5.5%) as early as December (as a dovish forward-guidance balance to an expected Taper announcement).


Via Goldman Sachs,

  • The most senior Fed staff economists for monetary policy analysis and domestic macroeconomics, William English and David Wilcox, have published separate studies that imply a strong case for a reduction in the 6.5% unemployment threshold for the first funds rate hike. We have proposed such a move for some time, but have been unsure whether it would in fact happen. And while the uncertainty around near-term Fed policy remains very considerable, our baseline view is now that the FOMC will reduce its 6.5% threshold to 6% at the March 2014 FOMC meeting, alongside the first tapering of QE. A move as early as the December 2013 meeting is possible, and if so, this might also increase the probability of an earlier tapering of QE.

It is hard to overstate the importance of two new Fed staff studies that will be presented at the IMF's annual research conference on November 7-8. The lead author for the first study is William English, who is the director of the Monetary Affairs division and the Secretary and Economist of the FOMC. The lead author for the second study is David Wilcox, who is the director of the Research and Statistics division and the Economist of the FOMC. The fact that the two most senior Board staffers in the areas of monetary policy analysis and domestic macroeconomics have simultaneously published detailed research papers on central issues of the economic and monetary policy outlook is highly unusual and noteworthy in its own right. But the content and implications of these papers are even more striking.

It will take us some time to absorb the sizable amounts of new analysis in the two studies, and we are only able to comment on a few selected aspects at this point. But our initial assessment is that they considerably increase the probability that the FOMC will reduce its 6.5% unemployment threshold for the first hike in the federal funds rate, either coincident with the first tapering of its QE program or before.

The first study, written by William English, David Lopez-Salido, and Robert Tetlow and entitled "The Federal Reserve's Framework for Monetary Policy--Recent Changes and New Questions," uses a smaller version of the staff's large-scale econometric model FRB/US to analyze the optimal path for the federal funds rate. Using "small FRB/US," a set of assumptions about Fed preferences, and a set of assumptions about the baseline performance of the economy, the authors find that the theoretically optimal policy involves a commitment to hold the federal funds rate near zero until 2017, followed by a series of hikes that push the rate well above neutral by the early 2020s. In this simulation, the unemployment rate falls below the structural rate for a time, and inflation rises modestly above the 2% target. (The optimal policy in the English et al. study is more aggressive than that shown in Vice Chair Yellen's earlier set of optimal control simulations, which points to the first hike in early 2016; the reasons seem to include a lower assumption for the structural unemployment rate and a later baseline for the first hike in the funds rate.)

However, the authors note that such an optimal policy is possibly infeasible because it is complex and model-dependent, and because it simply assumes that policymakers are able to overcome the credibility problems associated with a commitment to a particular policy path far in the future. Hence, they investigate several different ways in which Fed officials might be able to approximate the optimal policy: (1) different sets of unemployment and inflation thresholds for the first hike, (2) a higher inflation target, and (3) a switch to a nominal GDP level target. They see potentially sizable benefits from a higher inflation target or a nominal GDP level target but also very sizable risks, and conclude that "it is hard to be confident" that such a change would enhance performance.

Regarding the unemployment and inflation thresholds, they simulate the performance of unemployment thresholds for the first hike ranging from 5.0% to 7.0% and inflation thresholds ranging from 1.5% to 3.0%. The results with respect to varying the inflation threshold are not very surprising. The authors find that the current 2.5% threshold performs no worse than other choices, and the differences are relatively minor (at least in the baseline simulation). But the results with respect to varying the unemployment threshold are much more striking. The key conclusion is that "…reducing the unemployment threshold improves measured economic performance until the unemployment threshold reaches 5.5 percent; a further reduction in the threshold to 5.0 percent, however, reduces welfare, as the control of inflation becomes notably less precise." In other words, a 6% unemployment threshold outperforms a 6.5% threshold, and a 5.5% threshold outperforms a 6% threshold!

The second paper, written by David Reifschneider, Willam Wascher, and David Wilcox and entitled "Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy," discusses the considerable evidence that the US economy's supply-side performance has deteriorated significantly since 2007, with very slow potential GDP growth and an increase in structural unemployment. They estimate that real potential GDP growth has only averaged 1.3% since 2007, the output gap is currently about 3% of GDP, and the structural unemployment rate had risen to 5.75% by 2012 (although it is now again on a slight downward trend). They then use a modified version of FRB/US with an added role for "hysteresis" in labor markets--that is, a gradual transformation of cyclical unemployment into structural unemployment and/or labor force withdrawal --to analyze the sources of this deterioration, using a simulation in which the model economy is hit by a major financial crisis that is calibrated to match the size of the 2007-2009 episode. In a nutshell, they find that the post-crisis period "features a noticeable deterioration in the economy's productive capacity" and that about 80% of the deterioration "…represents an endogenous response to the persistently weak state of aggregate demand."

The authors then go on to discuss the "optimal" policy response to the crisis, taking into account not just the cyclical position of the economy but also the implications of weakness in aggregate demand for the supply side and therefore the longer-term structural position of the economy. They are careful to note that optimal control solutions are sensitive to the specification of the model economy, assumptions about the baseline performance of the economy, and assumptions about the Fed's objectives. But even with these caveats, it is striking that the optimal control solutions imply a period of near-zero interest rates that lasts until the unemployment rate has fallen to a level that is somewhere around the structural rate. This finding reflects the usual optimal control logic, namely that the central bank's objectives over the simulation period as a whole are best served by allowing for a period of modest overheating and overshooting of inflation in the more distant future in order to frontload a greater amount of monetary stimulus early on in the simulation period. But this logic is now enhanced by the hysteresis effects from weakness in aggregate demand on the supply side of the economy, which further increase the longer-term costs of failing to return to full employment.

The implications of the results strengthen further under an alternative assumption about the Fed's objectives. This is that Fed officials interpret the employment side of their mandate in terms of what we have called the total employment gap. As the authors note, "…optimal policy should become even more accommodative if the central bank did not target the unemployment gap but instead aimed at keeping the employment-to-population ratio near the trend level that would prevail in the absence of hysteresis effects and exogenous (but ultimately transitory) shocks to the natural rate." In fact, their simulations show that under this alternative assumption the funds rate remains at its current near-zero level until the unemployment rate has fallen about 1 percentage point below its structural rate.

Taking the two studies together, our preliminary takeaways are as follows:

First, the studies suggest that some of the most senior Fed staffers see strong arguments for a significantly greater amount of monetary stimulus than implied by either a Taylor rule or the current 6.5%/2.5% threshold guidance. To be clear, both studies contain a significant amount of caveats and offsetting considerations, as well as a disclaimer that they only reflect the views of the authors. But given the structure of the Federal Reserve Board, we believe it is likely that the most senior officials--in particular, Ben Bernanke and Janet Yellen--agree with the basic thrust of the analysis.


Second, the studies provide two complementary reasons for why additional easing is warranted, which correspond closely to our own recent analysis: (a) optimal control considerations that argue for "credibly promising to be irresponsible" and (b) the possibility that the economy is underperforming its "deep" structural potential--that is, the level of potential output that would have obtained in the absence of the demand weakness of the past five years--by much more than suggested by the current unemployment gap alone. These two reasons are additive in the sense that each provides a separate rationale for further easing, and taken together they provide a very strong rationale for such a move.


Third, the studies suggest that the most likely form of this additional easing would be a reduction in the 6.5% unemployment threshold, i.e. a further ramping-up of the primary form of forward guidance that the committee has already chosen. The discussion of QE--the other key form of unconventional policy currently in place--is quite scant; however, the English et al. paper notes that "uncertainty about the level of costs and efficacy…would lead to a reduced level of purchases." This discussion admittedly does not give us much to go on, but we would view it as broadly consistent with the idea that a reduction in the unemployment threshold might be accompanied by a tapering of QE.

The upshot from our perspective is that the probability of an outright reduction in the unemployment threshold has increased by enough to make this our baseline expectation. Admittedly, the uncertainty around what the committee will do to strengthen the guidance remains considerable. On the one hand, the discussion in the minutes of the September 17-18 FOMC meeting seemed to reveal more sympathy for an inflation lower bound--an option that does not receive any attention in the staff studies--than for a reduction in the unemployment threshold. On the other hand, both the English et al. study and at least parts of the Wilcox et al. study seem to make a fairly strong case for an even bigger reduction in the threshold, perhaps to as low as 5.5%. But our central case is now that the FOMC will reduce the threshold from 6.5% to 6% at the March 2014 FOMC meeting, alongside the first tapering of QE; however, a move as early as the December 2013 meeting is possible, and if so, this might also increase the probability of an earlier tapering of QE.


In other words... Goldman is expecting Taper to be announced at the December FOMC and believs the Fed need to cut its threshold on rate hikes to as low as 5.5% to balance the potential 'tightening' implicit in the Taper announcement that the market is likely be unhappy about... because - it would seem - Goldman (like many others) still do not understand that it is all about the "flow" not the stock.

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GetZeeGold's picture



Micro tweak......good call.....or is that twerk?


Is it too late to replace Yellen with Miley Cyrus?

semperfi's picture

Bernie Madoff for Fed Head ! 

NotApplicable's picture

God bless the Intelligentsia! Without them, one would be left with no choice but to label the whole system as a scam. Instead, we get the magic of the math of aggregates in an effort to construct a defendable facade.

Stackers's picture

I noticed Yellen mentioned focusing more on unemployment as the metric for policy change in her nomination acceptance speech as well.


She also added a 3rd mandate to the Fed's charter ..............

3mins worth watching.

spastic_colon's picture

they'll keep hammering away at the keysian dream until the economy actaully starts to look better in order to claim victory, lowering the thresholds was always a possibility the minute they added them as another "out" to a failed experiment.

semperfi's picture

the printing will continue until morale improves

NoDebt's picture

This "tapering", if it is ever attempted, should be worth a giggle.

They open the door, peek out, scanning to see if it's all clear outside.  They open the door a little wider, and take their first step outside.  Suddenly the market jumps out from behind a bush and yells "BOO!".  They're back inside in a flash, the door is shut and locked and, shaken, they vow never to go outside again.


LawsofPhysics's picture

So when do we (those on the outside) finally cut the fucking power?

GreatUncle's picture

The day the sheep decide to dump fiat.


BandGap's picture

The Fed still presents itself as an entity of the Federal Government. The greatest lie ever told and perpetuated.

We are on the last legs, years from now these times will be remembered as the days of lies.

roadhazard's picture

More like the Good ol' Days.

moneybots's picture

"The Fed still presents itself as an entity of the Federal Government. The greatest lie ever told and perpetuated."


The President, however chooses the person to head the FED.  As i have read, Truman ended FED independence in 1951.



LawsofPhysics's picture

While unlimited credit and money can be created from thin air with the click of a button, unfortunately, the calories that are required to do anything or create anything of real value cannot.

hedge accordingly.

Bro of the Sorrowful Figure's picture

there will be no tapering. QE will not slow down. it will accelerate until everything unwinds.

LawsofPhysics's picture



The good news;  We will all be trillionaires!

The bad news;  We will all be trillionaires!

SheepDog-One's picture

Bad news: a bagel and small coffee will cost $5 trillion dollars.

LawsofPhysics's picture

Got arable land and a dependable tribe?

B.J. Worthy's picture

Prepare for the Duggar monarchy

Second Class Citizen5's picture

I just hope that at that price we don’t have any shortages.

SheepDog-One's picture

I think Golden Slacks is trying to molest us here...they see 5.5% right around the corner, therefore tapering? Only if THEY make it up out of thin air.

semperfi's picture

Please hike your rates and blow up the system now.  Commit suicide and do us all a big favor.  Hurry!

Running On Bingo Fuel's picture

Wait till they get all of the cameras up and bullets out of the pipeline.

Oh, and we'll need some security detail for the Bankers, israeli's prefered.


Dr. Engali's picture

If they think that Yellen is going to start her reign of the fed with a market collapse, they are nucking futs. The Bernank is not going to announce a taper when he is going out, and Yellen will not start her term with chaos. The only solution then is to print moar. Not that the fed has any choice but to print to begin with.

Shizzmoney's picture

They will keep printing and never stop....beause they can't.

The only question is whether or not they will INCREASE the printing, not taper it (but you will hear rumors to the tilt to drive volatility so that speculators near the spigot can maniplate more gains).


Dr. Engali's picture

Yes they will print moar. Before you know it they will be printing 120 billion a month.

semperfi's picture

yep so the only question is WHEN will they announce the QE increase per month that is fit for public announcement - the real, private number of $print/month is much more

NihilistZero's picture

It seems like many you're under the delusion the FED can stop a mstock arket collapse.  The bond market wakes up and interest rates rise, the stock market collapses.  The FED increases QE and "becomes" the bond market and rates stay low, inflation goes nuts and the stock market collapses.  If, by some miracle, the FED tapers or raises rates, the stock market collapses.  Bernanke used up every resource to fuel this fake bull run.  Now the bull is gonna bend Yellin over and fuck her like she never has been before.  WWhich if you look at her she probably hasn't...


LawsofPhysics's picture

optimist, so long as the sheeple accept paper money, the music will keep playing.

SDShack's picture

I still think end of 1st qtr 2014 will prove we are in a double dip recession (not that we ever left the great recession). Look what's coming in the 1st qtr 2014. 0zer0care sticker shock is going to be replaced by 0zer0care wallet shock as people begin paying much higher premiums. The dismal holiday season results will be known, and will be much worse than anticipated. "Unexpected" cold weather will be blamed for higher energy costs, and driving consumers indoors as an excuse for the bad holiday sales. Unemployment will spike as seasonal holiday help is laid off and will have no place to go to find any jobs. Housing prices will decline (seasonal mostly), but that will just reinforce the recession feeling. THen there is the budget/debt farce that will just prove to people that Wash DC is just disfunctional and the out of control spending and taxes will just continue. Finally, add some ME turmoil to the mix, to spike gas prices, that carries into the spring/summer driving season and the wheels completely come off. Yellen will be yellin just like Paulson about "extraordinary measures" that will just be MOAR printing. Great for the bankers, but it is going to be a very bad winter and spring for the Sheep.

Bobbyrib's picture

Once again, if the rates get anywhere near their rate threshold, the government will be insolvent.

semperfi's picture

will be?

I'd say they are GAAP insolvent many times over to borrow a little lingo from our Indian friends.

firstdivision's picture

Okay, so a .25% rate hike is coming in December.  Thanks for the heads-up Goldman. Glad to know the Fed will wear a bomb vest.

q99x2's picture

I see higher rates and civil unrest and here comes the Santa Claus rally on behalf of the Washington D.C. politicians. That's how banksters do it. That's why they call them banksters. That's what banksters do.

SheepDog-One's picture

All this chicken entrails reading from Wall St aside...looks like they need the next 'crisis' this week! Stawks futures red, definitely can't have THAT!

Running On Bingo Fuel's picture

Goldman, goldman, GOLDman, goldMAN, goldman, g.o.l.d.m.a.n.


Seasmoke's picture

Unemployment the GREATEST lie of the Federal Reserve. 

BearClaw's picture

National unemployment is well above the current 6.5% threshhold for rate hikes, so moving the threshold number down to 6% raises the bar for rate hikes to be considered. In Goldmanspeak I guess that qualifies for a reduction.



sbenard's picture

So no matter how calamitous the consequences, the answer from the ivory tower academicians is MORE economic interventions and LESS liberty!

Calamity is certainty! Plan and prepare accordingly!!

bingaling's picture

They will never taper and they will never stop printing , the rest is a side show and irrelevant. Just another setup for a happier ending when yellen takes over the control-p button .

B2u's picture

They will continue to lower the threshold....first...6.5% will be lowered to 2014....later in the year, before the midterm elections...the rate will be lowered to 2015 the rate will not change...beginning in 2016....the rate will be lowered to save the Democrats....the rate will be lowered to 4.5% in August 2016...

goldenbuddha454's picture

Its time for the muppets to once again run into the burning theater

GreatUncle's picture

You just have to smile.

Told over and over unemployment is at this or that level. This baseline is determined by government who change the rules to make the numbers fit like one day you can be unemployed the next day not. It does not take into account the level of underemployment or the number inactive refused to be allowed into this unemployment number that will be used to calculate the forward guidance.

System is contructed flawed.

It fails to take into account the increasing efficiency now being implemented to do things for less that results in less hours because a TV is only a TV still if you cut the man hours otherwise it just will not work. When you have to earn an income, if it saves a few seconds off an employees time per unit made you are going to take it and why robotics is going to take off.

Might want to consider.

Cynically better to just use the number of inactive that incorporate the unemployed likely means you would never have to taper. Justified under this argument in an industrial world to live anywhere costs, taxes, etc so that income has to be obtained in some form either given or stolen.

The future guidance for me is this.

A sublime world where interest rates offered will be very suppressed for a long time indeed. If you cannot afford to service a new debt you can't exactly borrow it therefore lending subdued. Another type of loan, one off very short term and interest rate to suit called payday loans to bridge the lack of income.

Under such circumstances when the QE finally stops then likely it will not be long before it has to be restarted as for rate hikes? Short term high rate to make an income not the long term investment in a suppressed economy.


moneybots's picture

"forecasts that the Fed will lower its threshold for rate hikes to 6.0% (and perhaps as low as 5.5%) as early as December (as a dovish forward-guidance balance to an expected Taper announcement)."


The taper game again.

moneybots's picture

" forecasts that the Fed will lower its threshold for rate hikes to 6.0% (and perhaps as low as 5.5%) as early as December (as a dovish forward-guidance balance to an expected Taper announcement)."


Woop ti doo.

The market already knows the FED has no intention of rasing the FED rate any time soon.  Putting a number on it doesn't change anything.  It also doesn't prevent the FED from having to change its stance, if unintended consequences emerge.



polo007's picture

According to Macquarie Research:

Could the Fed flip flop?

“Enlargement” could become the new “tapering”

- Our view that tapering will commence in March 2014 has become the consensus and continues to be our base case (50% chance). We place a lower probability (15%) on an earlier taper (Dec/Jan) and a higher probability (25%) it occurs later (April to Sept). While incremental delays could impact near-term asset class performance these would only provide temporary respite from longer-term trends established when expectations for tapering began in early 2013.

- One outcome (to which we assign our final 10% probability) that would result in a more dramatic shift would be a 180 degree turn or flip flop in Fed communication that caused investor anticipation to move from “taper” to “enlargement”. The potential for such a shift is barely being acknowledged (no less considered!), by consensus. This is all the more reason to give it attention in our view. Such a flip flop would have important implications for asset market returns. In particular, it would likely lead to outperformance from emerging market equities and precious metals. Treasury bonds would also benefit.

The Fed would need to doubt the recovery’s sustainability

- Incoming data are an obvious catalyst for a Fed flip flop. The labour market has softened recently (Fig 8, 9), housing momentum has slowed (Fig 10, 11) and inflation is well below target (Fig 12, 13). Despite downgrades in its forecasts (Fig 14), the FOMC remains above consensus (Fig 15). While this evidence may be enough to delay tapering, modest downgrades or data misses likely won’t be enough to change the Fed’s tapering narrative.

- In our view, for such a flip flop to take place, members must become more pessimistic about the recovery’s sustainability. What might cause this? The combination of continued soft data alongside greater than expected fiscal tightening in 2014 is one possibility. It was the worry about the impact from the fiscal cliff, after all, that contributed to the QE3 launch decision in 2013.

And the Tea Party could provide the catalyst

- Consensus expects the Tea Party and other Republicans to take a less hardline approach towards negotiations in 1Q14 after they were punished in public opinion polls as a result of the shutdown. Such a near-term detente in Washington will only become likely should President Obama make concessions. Should this occur, the President may be more willing to sacrifice on near-term spending rather than changes to Obamacare (his legacy) or long-term entitlement programs (resistance from his own party) (see pgs 3 to 5).

- The magnitude required to impact the 2014 growth outlook is not high. Annual spending cuts offsetting just one-third of the long-term debt impact from Obamacare would act as an incremental ~0.4% headwind to growth in 2014 (combined with sequestration already embedded in current law, this would mean fiscal drag of ~0.5 to 1.0% for much of the year) (Fig 7).