The Fed strategy can be summarized this way
1 – The Fed sees a lower risk to the economy. Growth forecasts have been revised upwards in 2014. In March GDP growth rate was expected in the range [2.9 – 3.4] with a middle range growth rate at 3.15%. The forecast in June is in the range [3 – 3.5] with a middle range growth rate at 3.25%. Nevertheless for 2013 the central rate was revised slightly downwards to 2.45% as central rate midpoint against 2.55% in March.
The unemployment rate is revised downwards in 2013 to 7.25% in mid-range against 7.4% in the March forecast. For 2014 the expected unemployment rate is 6.65% in June versus 6.85% in March.
2 – Risks on inflation are not seen as major and the recent decline in inflation is understood as temporary before converging to the target of 2%.
3 – In the press release it is clear that the benchmark interest rate will remain in the range of 0% -0.25% and the amount of asset purchases will remain at USD 85Mds of dollars without changing the distribution (40 MBS and 45 in Treasury bonds)
4 – It’s in his preliminary remarks during his press conference that Bernanke has been more precise on the pace of monetary policy.
Asset purchases could be reduced before the end of the year if the economy follows the profile of the Fed forecasts. Purchases would stop then when the unemployment rate would reach about 7% probably in mid-2014 following the Fed forecasts.
5 – But Bernanke has once again been clear on this point: stopping the asset purchases will not trigger a rise in fed funds rate.
6 – The Fed chief said the move to reduce purchases would not necessarily linear and may be reversible in case of deterioration of the economy. The target of 7% by mid-2014 will be met if the scenario the Fed is respected.
7 – The rise in interest rates the Fed will require an unemployment rate below 6.5%. Bernanke has insisted that it was a threshold not a trigger for an interest rate increase. Forecasts show that a large majority of the FOMC members believes that the interest rate the Fed will not rise until 2015. There is even a member suggesting that it would be better in 2016.
The profile of the monetary policy is more accurate as we have details on factors causing a change. But the Fed did not provide a timetable as it does not want to tie the hands by a too precise temporal profile. If the pattern of growth expected by the Fed is respected then the decline in purchases could take place at meetings in September (17-18) or October (29-30)
For Bernanke these statements are part of the policy that has been implemented for several months, details provide clarification on the way the monetary strategy will effectively be put in place.
My perception is that these announcements should maintain relatively high long-term interest rates in the United States in anticipation of a rise in short rates. The risk is to have a very steep yield curve in 2014. For Bernanke this would mean better prospects and greater optimism about the U.S. economy.
In the short term the weak point will be on emerging markets as change in the Fed’s strategy will have an impact on capital flows dynamics that could be adverse for emerging countries.
If, as Bernanke mentioned it if the U.S. economy growth trend is strong enough then it will cause a spillover effect that benefits all. That is why he did not appear very concerned at this press conference.
The risk is that the Fed’s scenario could be too optimistic and too linear. If it is not the case this could lead to questions on the conduct of monetary policy. This could then be the source of additional volatility in the financial markets. The story is not over and again we will have to be very attentive to the forthcoming press conference following FOMC meetings.