The September FOMC meeting minutes continually refer to “tightening” as the primary concern, matching what I assumed when the decision was first announced in September.
“For example, questions were raised about the effects on the housing sector and on the broader economy of tightening in financial conditions in recent months, as well as about the considerable risks surrounding fiscal policy. Moreover, the announcement of a reduction in asset purchases at this meeting might trigger an additional, unwarranted tightening of financial conditions, perhaps because markets would read such an announcement as signaling the Committee’s willingness, nothwithstanding mixed recent data, to take an initial step toward exit from its highly accommodative policy.” [emphasis added]
The statement above alludes to perhaps some confusion on the Committee’s part as to why the market would “tighten” since data in recent months has been “mixed.” As the Committee apparently sees it, credit and dollar markets should have viewed the data in that light and concluded as much about tapering; funding markets, in fact, seemed to have made that determination on September 4, but not enough to fully restore pre-selloff levels.
Contradicting that “mixed” assessment somewhat, the FOMC spells out this confusing turn of bond market events (note the emphasized phrase):
“Members generally continued to see the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall, but indicated that the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market.” [emphasis added]
That statement suggests the bond market selloff and dollar “tightening” are the primary downside risk in the Committee’s estimation (take that for what it’s worth). To make sure that no observers missed their concern, they apparently voted for emphasizing it:
“In addition to updating its description of the state of the economy, the Committee decided to underline its concern about the tightening of financial conditions observed in recent months.” [emphasis added]
Accompanying the tightening financial markets was the inability of policy to bring below-target inflation upward.
“The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.”
This sanguine inflation outlook rests fully upon their expectation for their own efficacy:
“The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate.”
So, with “appropriate” policy “accommodation”, the economy should garner upward momentum which will both reduce the pressure on dollar tightening and simultaneously move inflation back up toward the long term target. Monetary policy is simply magic, or Goldilocks, or both. However, it seems to escape discussion, at least in the polished minutes (we will see in 5 years when the transcripts are released), why such magic wasn’t apparent in the past twelve months and that it should suddenly accrue potency where it did not exist previously. If policy had been as successful as advertised in September 2012, this discussion over taper and “mixed” economic signals doesn’t occur.
The bottom line appears to be that the bond market/funding market reaction to the threat of taper not only surprised them (which is common, they always seemed to be taken aback by events), it scared them out of a September action. That is one part of the minutes that is almost as clear, as a significant group of the members were adamant about tapering. The final vote must have been exceedingly close.
“Those [urging taper] participants generally were satisfied that investors had come to understand the data-dependent nature of the Committee’s thinking about asset purchases, and, because they judged that conditions laid out in June had been met, they believed that the credibility of the Committee would best be served by announcing a downward adjustment in asset purchases at this meeting.”
In other words, they backed themselves into a corner and should not risk losing credibility, the one real power of a central bank committed to psychology above all else. The part about markets adhering to data-dependent market expectations for taper was utter hogwash, as their own primary dealers indicated in that “surprising” selloff period.
Such a contradiction not only suggests a confusing economic outlook, again in contrast to expectations that policy actually works, it also projects confusion inside the FOMC itself. If the taper faction was correct about meeting all the June standards, then the market selloff was consistent with that view. How, then, could it have been “surprising?” The only affirmative answer is that they do not understand the markets they supposedly oversee with their distortions. Taper to the credit and funding markets is tightening, where the FOMC believes it to be only a minor adjustment. This view is confirmed by their continuing appeal to “forward guidance” for raising interest rates, including the idea that they are conveying “loose” policy despite taper all the way into 2015.
Bond markets all over the globe, not to mention the currencies of some of the largest economies, all hang in the balance over a group of economists that don’t know what tightening actually means until it has already taken place. Orbis non sufficit.
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