So the FOMC follows Qui-Gon Jinn’s advice and not Obiwan’s instincts. Yesterday’s FOMC release was a slightly hawkish shade of April’s release, which I (and the bond market) found disappointing.
Just before the announcement, I suggested an alternate FOMC statement that emphasized both downside inflation risks (which the Fed dropped in their statement) as well as the need for an eventual exit strategy. I think my version walked the line between acknowledging the continued downside risks in the economy, the very tenuous and limited nature of the nascent recovery, as well as an admission that non-traditional monetary policy carries a risk of inflation. I’ve written time and time again that inflation is a low probability risk, but the severe steepness of the yield curve says otherwise.
The Fed would love to flatten the curve. That would bring down mortgage and other borrowing rates, and actually aide the recovery. The way to do that is to calm the inflation fears. No matter how much I might deride the hyperinflation story, it isn’t going to magically go away. So if you are the Fed, why not assure the market that you are cognizant of this risks of quantitative easing? You don’t have to give a time frame to the removal of accommodation, but you do have to convince us that it will eventually be removed.