19th September 2013
The Federal Reserve has missed the perfect opportunity to start moving policy towards the exit says Schroders chief economist Keith Wade.
Wade says that given the comments of the Federal Reserve chairman Ben Bernanke that December looks like the most likely month for tapering to start although it could happen in December.
He says: “Clearly not enough has been done for the Federal Reserve (Fed) to believe that the gains in the labour market can be sustained. The tightening in financial conditions was a worry following the rise in treasury and mortgage rates, although the Fed Chairman also expressed concern about the imminent budget debates, the debt-limit issue, and the possibility of a government shutdown.
“With regard to the markets, risk assets will enjoy the ride and bond yields have already fallen sharply along with the dollar. The Bernanke put is back. Bubble concerns could return but the Fed would only have itself to blame: it has missed a perfect opportunity to start moving policy toward the exit.”
Graham Glass, head of fixed income at City Financial, says that the Fed also highlighted the fact that the headline unemployment rate is falling due to a reduction in those who are ‘participating in the Labour market.
“The Fed highlighted that the recent fall in headline unemployment rate to 7.3%, was largely due to a reduction in Labour Force Participation which, at 63.2%, is running at a 35 year low. The other key aspect of the Federal Reserve mandate, price stability, also shows that inflation is well below their target of 2%.
“Monetary policy decisions that go against market consensus rarely occur in the current environment and whilst there was a clear split between the economists forecasting tapering and those that did not (68.75% of economists polled by Bloomberg predicted a median of $5bn tapering in US Treasury purchases), the announcement of “no tapering” was met by sharply declining bond yields across the world. Just 10 business days ago, the US ten-year Treasury yielded in excess of 3.00%, the same bond yielded 2.69% at its close last night.”
David Harris, fund manager on the US Fixed Income team with Schroders says that everything in the run up to the decision suggested the Fed would start to taper. But that the likelihood of low interest rates even out as far as 2016 may see investors deploy cash back to the market.
“In Bernanke’s comments he lists a variety of reasons to hold steady for now, but the most interesting one is the increase in mortgage rates – which the Fed provoked with the taper talk. Clearly there is concern about the recent softer tone to economic data, part of which is from the impact of higher market borrowing costs. Downward revisions to 2013 and 2014 growth forecasts reflect the reality of ongoing tepid economic activity.”
Harris notes that shorter term interest rates are so far rallying much more than long rates, showing that the taper was fully priced in to long yields while the lower growth expectations should mean short term rates held near zero for longer.
“Ultimately the Fed will still need to scale back purchases. Not tapering now prolongs the uncertainty, and market volatility will remain high until the Fed is able to provide more clarity about their QE exit strategy”.
“Stronger growth forecasts in 2015 and 2016 notwithstanding, the Fed is clearly hinting that their unemployment threshold can be breached as long as inflation and inflation expectations remain well behaved. Given their 1.6-2.0% CPI forecasts as far out as 2016, this suggests that interest rates could possibly be held near to zero until that time. That will be a strong incentive for many investors to redeploy cash back into the market.”