“Information received since the Federal Open Market Committee met in May suggests that economic activity has been expanding at a moderate pace,” the U.S. Federal Reserve announced on Wednesday. The sentiment began a statement released after the conclusion of a two-day policy meeting, at which policy was left unchanged, as expected by most economists.
The markets may have not been expecting anything different, but the reaction was still visceral. Equities have grown addicted to accomodative monetary policy and QE. Everybody knows that the ride will have to end eventually, and Chairman Ben Bernanke has begun making noises indicating that the time will be soon.
So where do the Fed board members think we’re heading? Here are Fed projections and highlights from the post-meeting press conference.
Gross Domestic Product
Real GDP is expected to increase between 2.3 and 2.6 percent this year and accelerate through 2014. The longer run trend is slightly weaker — at between 2.3 and 2.5 percent — but reflects what seems like more reasonable growth expectations. Given current conditions, it would take a miracle to sustain 3.0 percent or higher economic growth in the long term.
Par for the course, Bernanke cited fiscal policy has a substantial headwind to overall economic growth: “Going forward, the economic outcomes that the Committee sees as most likely involve continuing gains in labor markets, supported by moderate growth that picks up over the next several quarters as the near-term restraint from fiscal policy and other headwinds diminishes.”
Unemployment expectations are still underwhelming, with forecasts showing near-full employment — currently ballparked at between 5 and 6 percent — only in the longer run. In his opening statement to the June 19 press conference, Bernanke commented that private payrolls were increasing at an average of about 200,000 per month.
“However, at 7.6 percent, the unemployment rate remains elevated, as do rates of underemployment and long-term unemployment,” Bernanke commented. “Overall, the Committee believes the downside risks to the outlook for the economy and the labor market have diminished since the fall, but we will continue to evaluate economic conditions and risks as they evolve.”
Fed board members are looking for PCE inflation to trend between 0.8 and 1.2 percent in 2013 before picking up steam. In 2014, expectations land in a range between 1.4 and 2.0 percent, the upper bound being the bank’s long-term target. To recap, the Fed set a 2.5 percent “threshold” (emphasis apparently necessary after Bernanke’s last press conference) as a criteria for a shift in interest rate guidance.
Bernanke commented: “As I have noted frequently, the phrase “at least as long” in the Committee’s interest rate guidance is important; the economic conditions we have set out as preceding any future rate increase are thresholds, not triggers. For example, assuming that inflation is near our objective at that time, as expected, a decline in the unemployment rate to 6-1/2 percent would not lead automatically to an increase in the federal funds rate target, but rather would indicate only that it was appropriate for the Committee to consider whether the broader economic outlook justified such an increase.”
When will policy firm up?
“In the projections submitted for this meeting, 14 of 19 FOMC participants indicated that they expect the first increase in the target for the federal funds rate to occur in 2015, and one expected the first increase to occur in 2016,” commented Bernanke.
To be clear, this is not the Fed setting a change in policy in stone. Bernanke repeatedly highlighted that any change in policy — open market or otherwise — will be dependent on economic conditions. This forecast is simply the aggregate of individual board member opinions.
In regard to asset purchases, Bernanke commented that “If the incoming data are broadly consistent with this forecast [those above], the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year; and if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear.”
What is the appropriate pace at which to firm up policy?
One of the most important things to take away from Wednesday’s press conference — and in fact one of the most important things to understand about Fed policy in general right now — is that the Fed expects to make changes to both open-market operations and its target funds rate slowly. It’s unclear what the tapering of purchases will look like, but FOMC members provided expectations for the funds rate.
It’s also important to point out that the Fed doesn’t intend to change the target funds rate until asset purchases end.