Via Goldman Sachs,
July minutes may reflect on the likelihood of September tapering, enhanced forward guidance
The July FOMC statement was a bit more dovish than expected, including (1) an explicit reference to the risks posed by higher mortgage rates, (2) more dovish language on below-target inflation, and (3) a statement that the Committee "reaffirmed its view" that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends.
We will read the minutes from the July meeting with an eye toward any clues on the likelihood of near-term tapering and potential changes to the forward guidance.
On the first point, within the discussion of the appropriate stance of balance sheet policy in the June minutes, "many members indicated that further improvement in the outlook for the labor market would be required before it would be appropriate to slow the pace of asset purchases." An adjustment to this language along the lines of many or most members expecting that it would soon be appropriate to reduce the pace of asset purchases would be a strong signal of near-term tapering, in our view.
In terms of dovish risks, particularly extensive discussion of the risk posed by higher mortgage rates (or tighter financial conditions in general) or lower-than-target inflation could be red flags that the Fed was thinking twice about near-term tapering. Since the July meeting financial conditions have tightened further according to our GS financial conditions index (FCI), although the latest core CPI print seems to confirm that the trough in core inflation may be behind us.
Also important will be how much the Committee emphasizes the recent trend in the data relative to cumulative progress toward its objectives since September 2012 (which was referred to a number of times in the June minutes). Further emphasis on cumulative progress would suggest additional momentum behind September tapering, while heightened focus on data-dependence would suggest that the August employment report (to be released September 6) may be a more important input into the Committee's ultimate decision than would otherwise be the case.
On forward guidance, we think it is likely that the Committee's July "reaffirmation" was a hint that enhanced forward guidance may be in the offing. This could potentially be expressed as an explicit reduction to the 6.5% unemployment threshold currently cited in the statement, or a more qualitative change to the language. Such a qualitative change could highlight the need to see a more broad based improvement in labor market indicators or a return of inflation toward the 2% target, in addition to unemployment below 6.5%.
Changes in the minutes that would suggest a heightened probability of enhanced forward guidance could include many members emphasizing the importance of keeping the overall level of monetary accommodation high, despite a shift in the "mix" of accommodation, to borrow Chairman Bernanke's phrase. In addition, in the June minutes "some" felt that the improvement in broad labor market conditions was less than that implied by the decline in the unemployment rate alone. "A number" or "many" participants sharing this view could suggest a near-term change to the forward guidance.
Other potential topics that may be addressed in the minutes include the degree to which MBS purchases and Treasury purchases may be tapered differently from one another, in particular in light of concern about higher mortgage rates, as well as guidance on when portfolio runoff may begin. Chairman Bernanke's recent remarks on the latter topic in his semiannual monetary policy testimony suggested that portfolio runoff would not start until rate hikes begin. This deviated from the June 2011 minutes' exit guidelines, which stipulated that portfolio runoff would begin before hikes to the fed funds rate.