Federal Reserve Chairman Ben Bernanke traveled to the House today to deliver his final Monetary Report to Congress. While he reiterated many of his previous comments surrounding quantitative easing and interest rates, Bernanke leaned on the dovish side of the equation in his testimony and Q&A. Bernanke continues to emphasize the distinction between asset purchases and interest rates as well as the data dependent nature of both. Overall, like his comments last week, Bernanke leaves me less confident of a September taper. Such uncertainty, I think, is one of his objectives.
At the onset of his testimony, Bernanke suggests that economic activity is broadly consistent with the Fed's forecast:
The economic recovery has continued at a moderate pace in recent quarters despite the strong headwinds created by federal fiscal policy.
But he quickly raises a red flag:
Housing activity and prices seem likely to continue to recover, notwithstanding the recent increases in mortgage rates, but it will be important to monitor developments in this sector carefully.
The Fed is understandably wary that the recent rise in rates will undermine the housing recovery, but also recognizes that rates are just one factor determining the demand for housing. See again FT Alphaville on this topic. Bernanke's assessment of the labor market is also mixed:
Conditions in the labor market are improving gradually...Despite these gains, the jobs situation is far from satisfactory, as the unemployment rate remains well above its longer-run normal level, and rates of underemployment and long-term unemployment are still much too high.
Then comes the decidedly dovish inflation outlook:
Meanwhile, consumer price inflation has been running below the Committee's longer-run objective of 2 percent.
And once again he dismisses the data:
This softness reflects in part some factors that are likely to be transitory. Moreover, measures of longer-term inflation expectations have generally remained stable, which should help move inflation back up toward 2 percent.
But then he raises the specter of deflation:
However, the Committee is certainly aware that very low inflation poses risks to economic performance--for example, by raising the real cost of capital investment--and increases the risk of outright deflation. Consequently, we will monitor this situation closely as well, and we will act as needed to ensure that inflation moves back toward our 2 percent objective over time.
If I had to say what surprised me the most over the past few months, it is that the tapering debate has proceeded so far and so long given below target and declining inflation rates. They are clearly placing considerable importance on a Phillips Curve view of the world in which they anticipate that falling unemployment will soon exert more upward pressure on inflation, otherwise they would have raised the pace of asset purchases at the last meeting rather than signal the end of quantitative easing.
Bernanke then muddles the risk to the forecasts. He first reiterates the message of the last FOMC statement:
The pickup in economic growth projected by most Committee participants partly reflects their view that federal fiscal policy will exert somewhat less drag over time, as the effects of the tax increases and the spending sequestration diminish. The Committee also believes that risks to the economy have diminished since the fall, reflecting some easing of financial stresses in Europe, the gains in housing and labor markets that I mentioned earlier, the better budgetary positions of state and local governments, and stronger household and business balance sheets.
That's a lot of good news. But he rains on the parade:
That said, the risks remain that tight federal fiscal policy will restrain economic growth over the next few quarters by more than we currently expect, or that the debate concerning other fiscal policy issues, such as the status of the debt ceiling, will evolve in a way that could hamper the recovery. More generally, with the recovery still proceeding at only a moderate pace, the economy remains vulnerable to unanticipated shocks, including the possibility that global economic growth may be slower than currently anticipated.
Interesting emphasis on the downside risks, particularly given that during the Q&A Bernanke said that recent data had not yet altered his basic outlook. Definitely sounds like he wants to take some of the certainty out of the path of asset purchases even if the current outlook is unchanged. This speaks to an effort to disabuse market participants of the notion that policy is calendar based.
Regarding policy, Bernanke continues to distinguish the Fed's policy tools and reiterate that policy remains accommodative even after the end of asset purchases:
We are relying on near-zero short-term interest rates, together with our forward guidance that rates will continue to be exceptionally low--our second tool--to help maintain a high degree of monetary accommodation for an extended period after asset purchases end, even as the economic recovery strengthens and unemployment declines toward more-normal levels. In appropriate combination, these two tools can provide the high level of policy accommodation needed to promote a stronger economic recovery with price stability.
Bernanke also repeats his performance in his last FOMC press conference:
If the incoming data were to be broadly consistent with these projections, we anticipated that it would be appropriate to begin to moderate the monthly pace of purchases later this year.
I do wish policy was more based on data being more "narrowly" consistent with the projections; "broadly" consistent leaves a lot of wiggle room. Note that Bernanke did suggest that so far the data remains within the range of broadly consistent. That 7% trigger comes back into play:
And if the subsequent data continued to confirm this pattern of ongoing economic improvement and normalizing inflation, we expected to continue to reduce the pace of purchases in measured steps through the first half of next year, ending them around midyear. At that point, if the economy had evolved along the lines we anticipated, the recovery would have gained further momentum, unemployment would be in the vicinity of 7 percent, and inflation would be moving toward our 2 percent objective. Such outcomes would be fully consistent with the goals of the asset purchase program that we established in September.
I don't think we know where that 7% number came from; St. Louis Federal Reserve President James Bullard claims it is not official policy and it doesn't show up in the minutes. But 7% it is.
Dovishly, Bernanke recognizes that financial conditions have tightened recently:
On the other hand, if the outlook for employment were to become relatively less favorable, if inflation did not appear to be moving back toward 2 percent, or if financial conditions--which have tightened recently--were judged to be insufficiently accommodative to allow us to attain our mandated objectives, the current pace of purchases could be maintained for longer.
The Fed was definitely surprised that rates reset following the last FOMC meeting. Indeed, even though rates fell today, the decline is a minimal few basis points compared to the rise since the spring. It seems that the Fed thought they were doing everyone a favor by signalling well in advance that policy was likely to shift by the end of the year, presumably so that markets would not be surprised and push up rates quickly. Policymakers, however, appear to have forgotten - again, for something like the third time in the last four years - that even talking about tighter policy is the same thing as tighter policy. Did they just sabotage their own desire to wind down asset purchases? Time will tell.
Bernanke pounds home this now familiar idea:
As I noted, the second tool the Committee is using to support the recovery is forward guidance regarding the path of the federal funds rate. The Committee has said it intends to maintain a high degree of monetary accommodation for a considerable time after the asset purchase program ends and the economic recovery strengthens.
And emphasizes thresholds are not triggers:
As I have observed on several occasions, the phrase "at least as long as" is a key component of the policy rate guidance. These words indicate that the specific numbers for unemployment and inflation in the guidance are thresholds, not triggers. Reaching one of the thresholds would not automatically result in an increase in the federal funds rate target; rather, it would lead the Committee to consider whether the outlook for the labor market, inflation, and the broader economy justified such an increase.
And then he questions the conditions around the unemployment threshold:
For example, if a substantial part of the reductions in measured unemployment were judged to reflect cyclical declines in labor force participation rather than gains in employment, the Committee would be unlikely to view a decline in unemployment to 6-1/2 percent as a sufficient reason to raise its target for the federal funds rate. Likewise, the Committee would be unlikely to raise the funds rate if inflation remained persistently below our longer-run objective.
Why does the same concern about labor force participation not hold for quantitative easing? If raising rates due to falling labor force participation is premature tightening, then why isn't ending quantitative easing also premature? And does anyone every wonder about these thresholds are in the first place? They seem to be the loosest of guidelines.
Regardless, Bernanke accomplished what he set out to do: Push back against the idea that the Fed will raise rates anytime soon. And he goes further:
Moreover, so long as the economy remains short of maximum employment, inflation remains near our longer-run objective, and inflation expectations remain well anchored, increases in the target for the federal funds rate, once they begin, are likely to be gradual.
The message is that policy will remain accommodative long after quantitative easing ends.
Bottom Line: Bernanke continues to inject uncertainty regarding the path of asset purchases, while at the same time creating more certainty about the path of interest rates. Altogether, part of his ongoing efforts to minimize the tightening that occurred in the run-up and aftermathath to the last FOMC meeting. But at the same time, he said the data remain broadly consistent with the path he outlined at the meeting, suggesting that the general policy path he outlined in June remains in play, which means beginning to wind down asset purchases later this year.