It's About The Calendar, by Tim Duy: St. Louis Federal Reserve President James Bullard explained his FOMC dissent in a press release this morning, and it was an eye-opener. I don't see how you can read Bullard's statement and not conclude that the primary consideration for scaling back asset purchases is the calendar. I think that the date, not the data, is more important than Fed officials like to claim.
Bullard first attacks the Fed's decision in light of falling inflation:
Federal Reserve Bank of St. Louis President James Bullard dissented with the Federal Open Market Committee decision announced on June 19, 2013. In his view, the Committee should have more strongly signaled its willingness to defend its inflation target of 2 percent in light of recent low inflation readings. Inflation in the U.S. has surprised on the downside during 2013. Measured as the percent change from one year earlier, the personal consumption expenditures (PCE) headline inflation rate is running below 1 percent, and the PCE core inflation rate is close to 1 percent. President Bullard believes that to maintain credibility, the Committee must defend its inflation target when inflation is below target as well as when it is above target.
No surprise here; Bullard frequently voices concerns about the path of inflation and inflation expectations on both sides of the target. The real action begins with the next sentence:
President Bullard also felt that the Committee’s decision to authorize the Chairman to lay out a more elaborate plan for reducing the pace of asset purchases was inappropriately timed. The Committee was, through the Summary of Economic Projections process, marking down its assessment of both real GDP growth and inflation for 2013, and yet simultaneously announcing that less accommodative policy may be in store. President Bullard felt that a more prudent approach would be to wait for more tangible signs that the economy was strengthening and that inflation was on a path to return toward target before making such an announcement.
Bullard's point is a good one. Why would the Fed lay out a plan to withdraw accommodation - which in and of itself is a withdrawal of accommodation - at a meeting when forecasts were downgraded? Because, as a group, policymakers are no longer comfortable with asset purchases and want to draw the program to a close as soon as possible. And that means downplaying soft data and hanging policy on whatever good data comes in the door. In this case, that means the improvement in the unemployment rate forecast. Just for good measure, let's add on a new policy trigger, a 7% unemployment rate. In my opinion, it is not a coincidence that they picked a trigger variable where their forecasts have been most accurate or even too pessimistic. They loaded the dice in their favor.
Bullard then goes one step further:
In addition, President Bullard felt that the Committee’s decision to authorize the Chairman to make an announcement of an approximate timeline for reducing the pace of asset purchases to zero was a step away from state-contingent monetary policy. President Bullard feels strongly that state-contingent monetary policy is best central bank practice, with clear support both from academic theory and from central bank experience over the last several decades. Policy actions should be undertaken to meet policy objectives, not calendar objectives.
Key words: "calendar objectives." Bullard clearly felt the mood in the room was something to the effect of "We know the data is soft, but we want out of this program by the middle of next year, so we are going to lay out a program to do just that."
In light of Bullard's dissent, the market's reaction should be perfectly clear. I have seen some twitter chatter to the effect of market participants didn't understand what Federal Reserve Chairman Ben Bernanke was saying, that his message was really dovish, that interest rates would be nailed to the zero bound in 2015, that the policy was data dependent, etc. Market participants obviously didn't have that interpretation.
Indeed, I think market participants clearly heard Bernanke. After weeks of being soothed by analysts saying that the data was key, that low inflation would stay the Fed's hand, Bernanke laid out clear as day a plan for ending quantitative easing by the middle of next year. Market participants then concluded exactly what Bullard concluded: It's the date, not the data.
With that information in hand, market participants did exactly what they should have been expected. I think Felix Salmon has it right:
What we really saw today was not a move out of stocks, or bonds, or gold, but rather a repricing within each asset class.
The Fed changed the game this week. Bernanke made clear the Fed wants out of quantitative easing. While everything is data dependent, the weight has shifted. The objective of ending quantitative now carries as much if not more weight than the data. Market participants need to adjust the prices of risk assets accordingly.
Bottom Line: I think the question is not how good the data needs to be to convince the Fed to taper. The question is how bad it needs to be to convince them not to taper. And I think it needs to be pretty bad.