The latest challenge for the Fed just got a little easier. The unemployment rate that had been declining rapidly toward the Evan’s Rule threshold guidance level of 6.5% eased back from 6.6% to 6.7% at the release of the February employment report earlier this month. As the unemployment rate moved more quickly than expected toward that threshold over the last months, Fed officials made clear it was not a trigger and that other variables were being considered as a guide to when monetary policy would become less accommodative. However, the guidance provided by that 6.5% unemployment threshold has been lost and there is little reason to continue its use. The Fed is interested in advancing an alternative guidance that will offer support for economic progress by strongly discourage economic agents from pricing too-soon a lift-off for the fed funds policy rate.
The Fed will in all likelihood simply drop the reference to the 6.5% unemployment rate, otherwise leaving much of the same message as before. They could provide additional insight as to particular economic and financial measures considered, but they would not want to get too bogged down with specifics. Instead, simply being able to point toward a varied collection of economic and financial market performance measures and further being able to note those measures are not yet at levels where the Fed would consider removing accommodation could be a powerful message. Such language could be used until just before the Fed chooses to lift policy rates.
Few if any believe the Fed has any intention of raising policy rates before the tapering of asset purchases is completed late in the third quarter of 2014. Fed statements have led most of the more hawkish Fed watchers to believe that the Fed would not raise fed funds policy rates for a minimum of three to six month following the completion of asset purchases. Still, the Fed would like to have the market price that event further out in the future in order to continue to promote stable and low long-term Treasury yields.
Efforts to promote expectations for a more distant lift-off date using the FOMC statement change that drops the 6.5% unemployment threshold guidance and replaces with qualitative guidance can be further supplemented by reference to the Summary of Economic Projections (SEP). Some have argued that SEP values be used within the context of the FOMC statement to provide rules as to when the Fed should be expected to change policy. Such use of SEP information not recommended as it may raise creditability concerns. However, Fed Chair Yellen could discuss in the post-meeting report and Q&A the value of relying on such projections to recognize FOMC participant’s understanding of future values for policy rates and other economic variables.
Expectation for longer-run real GDP and fed funds policy rates add insight into future long-term Treasury yields. There has been a steady decline in the Fed’s (SEP) forecast for longer-run real GDP. In January 2009 as the Fed moved to provide more formal quarterly updates for economic variables in the form of the SEP, Fed participants provided a central tendency forecast for longer-run real GDP of 2.5% to 2.7%. This longer-run central tendency forecast was increased to 2.5-2.8% in November 2009 and remained at that level until November 2011 when it was again reduced to 2.5-2.7%. Central tendency expectation for real GDP has steadily declined since. In December the upper bound of the 2.2% to 2.4% range was below the lower bound (2.5%) from two years earlier.
Clearly expectations for longer-run growth have been scaled back. So too have expectations for longer-run "appropriate" fed funds policy rate. Starting in January 2012, the Fed began providing quarterly updates in the SEP for year-end value for fed funds policy rates expected over the next three year, as well as the expected longer-run policy rate. The average of the participant’s rate projections has steadily declined from a starting value of 4.21% in January 2012 to 3.88% at the most recent December 2013 update.
The SEP has additionally provided information about the expected path for fed funds policy rates over the coming three years. Since it has been providing such data, the participant’s expectations for the year-end value for policy rates in coming years has consistently been marked lower. We should expect the upcoming SEP that accompanies the March 2014 FOMC meeting to show still lower expected rates in future years. At least one of the two participants who in December had higher rate forecast for 2014 is expected to move that expectation to 2015. Additionally, one or more participants may also move from 2015 to 2016. The chart below shows the average year-end rate forecasted by Fed participants at the last 4 quarterly updates for SEP.
We should expect to hear additional references to the declining trend of expected year-ending and longer-run fed funds policy rates over the coming months as it will help to support the Fed’s goal in limiting the increase in long-term Treasury rates as the Fed completes its purchase plans. It may be the cleanest form of support for policy intent.
On weaker data and tapering
The Fed’s Beige Book made clear that Fed officials had difficulty reconciling economic progress as a result of challenging weather conditions. The report made reference to weather 25 times within the summary alone. Still, there are some who believe some more fundamental slowing of the economy is evidenced in the data over the past months. The Fed however is not prepared to react hastily, but instead should be expected to continue on its present course of tapering.
Tapering of securities purchases has been moving along smoothly and we are left to expect the Fed will continue to reduce the level of monthly purchases by a "measured step" reduction of $10 billion per FOMC meeting. Fed officials have made repeated remarks about there being a ‘high bar’ for changing that pace. You are invited to review my last FOMC report for a more detailed discussion of the "policy-path" implications of tapering. We might note here however that the main difference between the mid-2013 declaration of tapering intent and the December 2013 FOMC implementation of that intent was the stated path for tapering with strong implication for the level increment. In the absence of that ‘policy-path’ expression, the mid-2013 discussion of tapering found only sellers of Treasuries and a jump in term premium.