The bad mojo that brewed in the markets this week largely dissipated following the release of the Federal Open Market Committee meeting minutes from July. All told, there were few surprises in the report. With economic conditions on the upswing, Fed officials have made no secret of the possibility that tapering could begin as early as this year, and comments from the minutes are consistent with this idea:
“Almost all participants confirmed that they were broadly comfortable with the characterization of the contingent outlook for asset purchases that was presented in the June postmeeting press conference and in the July monetary policy testimony. Under that outlook, if economic conditions improved broadly as expected, the Committee would moderate the pace of its securities purchases later this year.”
Word on the street is that September 19 — the second of the FOMC’s next two-day meeting — is when an announcement will be made. Dallas Fed President Richard Fisher and Chicago Fed President Charles Evans have both indicated that the decision could be made at this meeting, and a majority of economists recently polled by Reuters also point their fingers at the September date.
The operative language from the minutes — language which has been echoed by policymakers before — is “if economic conditions improved broadly as expected.” It has been emphasized time and again that monetary policy will remain responsive to incoming economic data. Over the past few months, the data have been broadly consistent with the forecasts compiled by Fed policymakers and presented earlier in the year.
The Fed is forecasting overall economic growth — as measured by change in real gross domestic product — of between 2.3 and 2.6 percent in 2013 and between 3 and 3.5 percent in 2014. Unemployment is forecast to fall to between 7.2 and 7.3 percent in 2013 and between 6.5 and 6.8 percent in 2014. Annual inflation is expected in a range between 1.2 and 1.3 percent in 2013 and between 1.4 and 2 percent in 2014.
The Fed, to put it one way, has had its foot slammed on the monetary gas pedal since 2008, when QE 1 — a program to purchase $600 billion in mortgage-backed securities — went into effect. This and subsequent programs like the current iteration has the Fed purchasing $85 billion in longer-term securities and MBS each month, increasing the Fed’s balance sheet to more than $3.5 trillion and distorting financial markets. As Dallas Fed President Richard Fisher put it earlier this month:
“A corollary of reining in this massive monetary stimulus in a timely manner is that financial markets may have become too accustomed to what some have depicted as a Fed ‘put.’ Some have come to expect the Fed to keep the markets levitating indefinitely. This distorts the pricing of financial assets, encourages lazy analysis and can set the groundwork for serious misallocation of capital… The challenge now facing the FOMC is that of deciding when to begin dialing back (or as the financial press is fond of reporting: ‘tapering’) the amount of additional security purchases.”
Over the past couple of years the Fed has evolved from a monetary institution trying not to step on the toes of the free market — think Greenspan Doctrine — into something of a cross between a financial watchdog and monetary guide dog. Through its currently highly accommodative policy, particularly its program of quantitative easing, the Fed is attempting to stimulate market and economic activity by effectively lowering the cost of money and increasing the availability of credit.
On the other hand, the Fed is also trying to make sure that all this easy money doesn’t inadvertently inflate the same asset bubbles whose collapse contributed to the late 2000s crisis. Ensuring that these bubbles don’t re-inflate will certainly be on the minds of Fed policymakers as they head into the September meeting.
Market reaction to the minutes was about as good as it could have been. Equities dipped sharply lower immediately following the release — perhaps some function of market psychology, or the automatic selling of algorithm traders — but broke back into positive territory about half an hour later.
The Fed’s bond-buying program has been particularly stimulating for equity markets, which have been routinely refreshing all-time highs recently. The comparison may be stretched, but QE has acted like amphetamine for the stock market, and just the idea of the Fed tapering purchases has sent the markets careening downwards. This is why Mr. Market has had his eye fixed on the Fed for so long — QE won’t last forever, and its wind-down will have an effect on equity valuation and investing behavior.