The US Federal Open Market Committee decided to keep the federal funds target rate unchanged at 0.00% to 0.25% and said it would continue purchasing $85 billion a month of agency mortgage-backed securities (MBS) and longer-term Treasury securities. However, at the press conference Chairman Bernanke provided a broad outline of how QE tapering could proceed.
In making their policy decision the FOMC highlighted the following key points about the economy:
- Economic activity has been expanding at a moderate pace.
- Labour market conditions have shown further improvement in recent months, but the unemployment rate remains elevated.
- Household spending and business fixed investment advanced, and the housing sector has strengthened further.
- Fiscal policy is restraining economic growth.
- Downside risks to the outlook for the economy and the labour market have diminished.
- The Fed anticipates that inflation, over the medium term, will likely run at or below its 2 percent objective.
Bernanke also announced that the Fed could begin tapering QE before end 2013 – as long as the economy progresses in line with the Fed’s base forecast. This includes both their growth and employment forecast as well as their inflation forecast (see charts attached). The QE tapering could be completed by mid-2014 – again assuming the economy progresses as expected by the Fed. Clearly, if these forecasts are not achieved then tapering could be delayed. Bernanke stressed that the Federal Funds Target Rate will be maintained at its current historically low rate well after QE tapering ends. In fact, the exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6.5% (the majority of the Fed committee expects rates to start to rise in 2015). Also the Fed will continue to hold MBS and government bonds long after tapering ends, and will continue to re-invest interest and principal receipts.
The critical take-away from the Feds announcement is that QE tapering will be highly dependent on continued economic growth, especially a further reduction in the unemployment rate (7.25% is now the critical level for tapering to begin and Bernanke expects the unemployment rate to be down at 7% by the time tapering ends) but also a rise in the inflation rate to around 2%. If inflation remains exceptionally low, but the growth targets are achieved the Fed could still hold-off on tapering QE. Overall the Feds announcement is actually a bullish statement about the state of the economy. US 10-year government bond yield kicked higher following the announcement (2.32%), which is to be expected. Equity markets a little unsure, trying to balance the Feds bullish statement against the tapering announcement. The announcement is not good news for emerging market fixed interest instruments as well as emerging market currencies.Download the presentation slides