QE3

The Federal Reserve told us in December last year that it would maintain its asset purchases until the outlook for the US labour market had improved substantially. Does Tuesday’s rather anaemic jobs data release meet this criterion any more than it did last month, when the Fed decided not to taper its asset purchases? Not really.

The underlying pace of job gains is certainly not rising, and may even have fallen slightly. But the unemployment rate dropped to 7.2 per cent, and the pace of decline suggests that the 6.5 per cent threshold for considering interest rate rises could be reached in mid-2014, ie before the balance sheet tapering has ended! This gives Janet Yellen, the incoming Fed chairman, an early problem: she will surely have to reduce that 6.5 per cent threshold soon.

In this blog, we use some statistical tools which have been developed by the regional districts of the Fed to frame a judgment about the underlying state of the labour market, updated to include this week’s new information [1]. Read more

When we look back on the FOMC meeting on June 19 2013, it will probably be seen as the moment when the Fed signalled that it was beginning the long and gradual exit from its programme of unconventional monetary easing. The reason for this was clear in the committee’s statement, which said that the downside risks to economic activity had diminished since last autumn, presumably because the US economy had navigated the fiscal tightening better than expected and the risks surrounding the euro had abated.

This was the smoking gun in the statement. With downside risks declining, the need for an emergency programme of monetary easing was no longer so compelling. The Fed has been the unequivocal friend of the markets for much of the time since 2009, and certainly ever since last September. That comfortable assumption no longer applies.

Fed chairman Ben Bernanke, however, went to great lengths to mitigate the hawkish overtones of this message in several respects. The asset purchase programme would be ended only when the US unemployment rate has fallen to 7 per cent, which the central bank expects to happen by mid-2014, he said. In the meantime, the pace of asset purchases could be increased as well as reduced, depending on the incoming economic data. Read more

Professor Michael Woodford of Columbia University is an extremely renowned macro-economist, and rightly so, but only recently has he occupied a central place in market thinking. Since his paper on US monetary policy at Jackson Hole, and the favourable remarks which Ben Bernanke made about him, everyone is trying to understand what his influence on the Fed might eventually mean.

His writing can be complex and intricate, which is in the nature of the subject, but his current policy recommendation is quite clear: the Fed should adopt a target for the level of nominal GDP which would have the effect of increasing price inflation, and inflation expectations in the period ahead, and thus reduce the real rate of interest.

If the controlling majority which surrounds the chairman on the FOMC has fundamentally accepted the thinking which backs these recommendations, as many investors believe, then there has been a profound change in Fed strategy. However, I am not convinced that this is the case. Mr Bernanke has not yet crossed the inflation Rubicon. Read more

Ben Bernanke has boldly gone where no Fed chairman has gone before him with his third round of quantitative easing. Gavyn Davies discusses with the FT’s Long View columnist John Authers why Mr Bernanke has chosen this path – and its risks:

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 As they meet today the Federal Reserve’s governors face a dilemma; with unemployment creeping lower while inflation rises, can they justify a third round of stimulative quantitative easing? Gavyn Davies, chairman of Fulcrum Asset Management, explains to Long View columnist John Authers that while the Fed is keen for QE3, it needs to bring inflation more under control first.  (5m 27sec)

The Fed decision was fairly close to what was anticipated in this earlier blog – all “twist” and no “shout”. However, on balance, the statement was slightly more dovish than I expected. Concerns about downside risks to economic activity were at least as great as in last month’s FOMC statement, with new downside risks from financial strains being specifically mentioned, and this has swayed the majority of the committee to introduce a slightly more aggressive operation “twist” than expected. Inflation concerns, while marginally greater than in the August FOMC statement, are clearly insufficient to impress the committee, which remains biased towards further easing even after today’s announcement.

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Opinion is sharply divided about what the Fed intended to signal in the statement issued on Tuesday. Some have seen the statement as very dovish, because it said that the Fed intended to leave short rates at “exceptionally low levels” until mid 2013 – the first time that a specific date of this sort has ever been set by the FOMC.

Others, however, concluded that the statement contained nothing really new, since the markets had already assumed that short rates would be close to zero for the next two years. Furthermore, the fact that there were three dissents from the majority decision has led some to deduce that the further large step to more quantitative easing (QE3) is still a long way off. On this view, nothing really changed. Read more

Ben Bernanke

Ben Bernanke. Image by EPA.

The financial markets seem determined to interpret today’s statement by the Fed chairman in a dovish light, but a careful reading of his words does not support that point of view. True, Mr Bernanke outlined the possible ways in which monetary policy might be eased further if recent economic weakness should prove more persistent than expected. But he gave equal weight to the possibility that “the economy could evolve in a way that would warrant less-accommodative policy”.

There was no hint in the text about which of these outcomes he considered the more likely. We already knew from yesterday’s FOMC minutes for the June meeting that the committee is split about the likely evolution of policy, and we were waiting to see today whether the chairman would throw his weight behind either the doves or the hawks. He failed to do either. Read more

The US employment numbers for May seemed to surprise the markets, but in fact they confirmed what we already knew from a string of earlier data releases, which is that the economy has slowed very markedly in recent months. The debate now is whether this slowdown has been triggered mainly by transitory factors – the fallout from the Japanese earthquake, stormy weather, and a spike in gasoline prices above $4/gallon – or whether it reflects a more fundamental malaise in the economic recovery.

The equity markets have remained fairly upbeat about this, and most economists are still strongly of the view that this is just another mid-cycle slowdown of the sort which occurred last year. This still seems to be the most probable outcome (as I will argue here on Sunday). But what if this optimism is wrong? Is there a Plan B? Read more