A New Direction for Forward Guidance

image provided by wikipedia.org
image provided by wikipedia.org

Fox Business Article

Charles Plosser, president of the Federal Reserve Bank of Philadelphia, said in a March 10 speech that the weaker economic indicators should not cause the Fed to pause the taper.

Paul Edelstein, director of financial economics at IHS Global Insight, calls it a “foregone conclusion” that the Fed will continue its taper, probably reducing bond purchases by another $10 billion. “The taper is sort of a fait accompli,” he says.

Edelstein says one of the bigger discussions at this meeting may revolve around the Fed’s published guidance on when interest rates will eventually rise.

William Dudley, president of the Federal Reserve Bank of New York… [said] “reasonable time to revamp (the forward guidance) statement to take out that 6.5% threshold because it’s not really providing any great value.”

My opinion: Whelp, it appears to be a “foregone conclusion” that the taper will continue.  Personally, I have been rallying behind the idea that a reduction to the taper would provide an appropriate and timely, positive  shock to the stalling labor market and puttering inflation — along with my comments from yesterday’s post.

With the taper being set in stone, the real story from this meeting will be an expected change to the forward guidance.  The 6.5% unemployment threshold has little to no impact anymore with regards to expected interest rate hikes.  So what will it be changed to?  The last FOMC statement in January contained the following:

 In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.

Since the Federal Reserve operates under a ‘dual mandate’, I would predict the new guidance would surround inflation risk, particularly downside risk.  Possibly a statement like “until downside risk to inflation reaches a level consistent with our objective over the medium term, the Federal Reserve’s monetary policy stance will remain highly accommodative”.

This sort of statement has the benefit of being broad enough to maintain relevance over the next 1-2 years while also providing a substantial amount of information.  Everyone knows the Fed targets a 2% level and inflation rates come out every month and are just as easy to interpret as unemployment data which allows investors to appropriately align their expectations.

All-in-all, I believe the Fed cuts its bond buying program by another $10 billion and forward guidance changes to the “downside risk” of inflation.

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