Via Guy Haselmann of Scotiabank,
What Bernanke Might Want to Say
In past speeches, Bernanke has said that central banks should not surprise markets. However, he has also said that central banks should not threaten action, because the threat is then counter-productive to what they are trying to achieve under current policy. Therefore, waiting 2.25 months until the September meeting seems impractical to me and counter to earlier speeches.
Bernanke can use his speech today to bring clarity to the market, while limiting market damage. For the reasons mentioned, he may want to hint at an earlier-than-expected tapering (say at the July meeting rather than the September meeting). At the same time, he may want to emphasize asset purchases may continue for longer than expectations. Of course, he will also emphasize that tapering is merely a slowing of the rate of purchases (slower easing) and that a rate increase in a long way off. Trying to extend forward guidance at the same time that he moves forward the initial timing of tapering will help limit an adverse market reaction.
One reason the Treasury market priced in a Q4 2014 rate hike – moving the first hike forward by 6 months after the June FOMC – was because the FOMC central tendencies lowered the low end of its unemployment rate forecast for end-2014 to 6.5%, which is the Fed’s target for the first rate hike. Bernanke may wish to verbally lengthen this assessment.
Bernanke may wish to say something about the revised exit strategy guidance paper (from January) that is likely to be released at the July meeting. The original paper said that QE will likely end 6 months after the first taper and rates will be hiked 6 months after QE ends. Bernanke may wish to hint that both of these time frames are likely to be extended. In addition, the FOMC noticed (likely with angst) the rise in mortgage rates. Bernanke can use this opportunity to emphasize that no Fed mortgage assets will ever be sold (but rather allow to run-off). The first paper discussed asset sales, but Bernanke said at the June FOMC press conference that the Fed does not intend to sell any mortgages.
Background, Reasoning, and Justification
Bernanke gives a speech today in Boston beginning at 4:10 PM entitled “The First 100 Years of the Federal Reserve: The Policy Record, Lessons Learned, and Prospects for the Future”. There will be a post-speech ‘Question & Answer’ period. This is an ideal time for him to fine-tune the Fed’s complicated message to markets. He can use this opportunity to send up a trial balloon for next week’s semi-annual report to Congress. I suspect Bernanke could even have his staffers leak questions to ask to those in the audience in order to frame and direct the conversation.
I believe the Fed has drifted toward acceptance of tapering because of concerns about: 1) financial instability, 2) asset bubbles and 3) amassing difficulties for its exit strategies, not because economic nirvana has been reached. The FOMC likely recognizes that economic strength is not ideally where they would like it to be, but they understand that $85 of monthly asset purchases has a greater impact on asset prices than it does on lowering the Unemployment Rate (UR). Therefore, I believe the decision to taper at one of the next two meeting is almost a certainty. “Data dependency” will dictate the length and pace of QE, but will no longer delay the tapering start date past the next few months.
Bernanke can site “progress” as the reason for tapering. The UR has fallen from 8.2% to 7.6% and employment has expanded by over 200k jobs per month on average over the last 6 months. A tapering announcement would afford the FOMC the opportunity to get all members on the same, increase their flexibility going forward, and remove it as an uncertainty overhanging markets.
In addition, I reference a January 2013 FED paper that discusses the evolution of the Fed balance sheet. Exit strategy projections are in sections 3.2 and 3.3...
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