There was some initial consternation yesterday after Federal Reserve Chairman Ben Bernanke gave the clarity we were hoping to see. From Reuters:
"If we see continued improvement and we have confidence that that's going to be sustained then we could in the next few meetings ... take a step down in our pace of purchases," he said.
"Next few meetings" sounds like September at the eariliest. Indeed, September or December are the most likely meetings given both have an associated press conference.
For financial market participants, I would say this was a mixed message. Bernanke is dovish if you expect the Fed to move in June, hawkish if December at the earliest. But imagine the message that would have been delivered to financial markets had Bernanke not spoken ahead of the minutes of the April FOMC meeting:
A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome.
It seems to me that the threat of an imminent policy change would have been taken very poorly had Bernanke not already spoken yesterday morning. So, in a sense, Bernanke saved traders from an even more tumultuous day. Expect Bernanke to use the June press conference to lay the ground work for a reduction in the pace of purchases as early as September.
From a different viewpoint, Bernanke might have just sandbagged his colleagues. Recent comments from Federal officials suggest they reasonably believed they were close to cutting the pace of purchases, and it seems like they received this impression from the discussion in the last few FOMC meetings. Hence, for example, why San Francisco Federal Reserve President John WIlliams felt comfortable suggesting an imminent reduction in the pace of purchases as recently as Monday of this week. Bernanke, however, sets everyone straight. It's not going to happen this summer. Maybe fall.
Notice also the communications challenge. Even as participants coalesced around a policy shift as early as June, they did not have internal agreement on what would justify such a shift. I am not sure how they communicate policy if there is no central view as to what should justify a particular policy. One gets the feeling that the Federal Reserve treats "strong and sustained growth" like the Supreme Court treats pornography: They will know it when the see it.
The communications plot thickens later in the minutes:
A few members expressed concerns that investor expectations of the cumulative size of the asset purchase program appeared to have increased somewhat since it was launched last September despite a notable decline in the unemployment rate and other improvements in the labor market since then. In contrast, a few other members focused on evidence that market expectations about the total size of the program had changed little, on net, since the program was launched or had responded appropriately to incoming information. Members generally agreed on the need for the Committee to communicate clearly that the pace and ultimate size of its asset purchases would depend on the Committee's continued assessment of the outlook for the labor market and inflation in addition to its judgments regarding the efficacy and costs of additional purchases and the extent of progress toward its economic objectives. To highlight its willingness to adjust the flow of purchases in light of incoming information, the Committee included language in the statement to be released following the meeting that said the Committee was prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.
The second sentence in this paragraph is a little bit clunky. But overall it sounds like there is concern among some officials that market participants are not sufficiently responding to incoming information. In other words, the Fed expected that incoming information would trigger a continuous reassessment of the pace of asset purchases, but they are not seeing that continuous reassessment reflected in expectations. Hence the reminder that policy is not a one way street.
I am thinking this morning that the Fed is asking an awful lot from market participants; if policy officials cannot agree on what constitutes sufficient evidence to trigger a change in policy, how can officials expect such knowledge on the part of market participants?
From all of this I am reminded of one important thing: Staying on top of the likely path of monetary policy means tracking Bernanke. Be wary of regional Federal Reserve presidents. What seems to happen is this sequence of events:
- Bernanke speaks.
- We all reach a common assessment of the policy path
- Bernanke drifts into the background amid a cacophony of Fed speakers.
- Our view of the policy path begins to splinter as each Fed speaker has a different interpretation of the implication of the data flow for policy.
- Bernanke speaks.
- We all reach a common assessment of the policy path.
- Repeat steps 3 through 6 above.
Bottom Line: Assuming the recent pace of activity continues through the summer, it is reasonable to expect the first cut in the pace of QE to begin as early as September. While the Fed will continue to say that they could adjust policy up or down, I don't believe that they really believe this. I think they expect the first reduction in the pace of easing to be the first stage to ending quantitative easing; as such, it is not their intention to start the process until they firmly believe they will not have to backtrack. A good reason to delay through the summer, in my opinion. Finally, there is a very, very simple way to improve communications: Bernanke needs to give more speeches directly pertaining to the policy path.