The FOMC pulled yet another rabbit out of the hat by holding off on the expected taper, slamming down on analysts (including yours truly) who thought the Fed would pull the trigger today. Two significant factors that held the FOMC in check were fiscal policy and higher interest rates. From the statement:
Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen further and fiscal policy is restraining economic growth…
…Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall, but the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market.
Now, why did financial conditions tighten? Oh yes, I recall – because just talking about tapering is the same as tightening. Remember, unless yields head much lower (they are down around 10bp as I write), much of the damage is already done is already done.
Holding off on tapering also achieves two other objectives. The first is to make clear that policy is data dependent:
However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases….Asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s economic outlook as well as its assessment of the likely efficacy and costs of such purchases.
The second – assuming we now have an Octaber to look forward to – is that the Fed can prove it can change policy in meetings not followed by a press conference.
The downside is that there has been a clear communication failure on the part of the Federal Reserve, and this should not be overlooked in the hysteria that will surround this announcement. If they are concerned about the impact of higher rates now, the Fed should have worried a little bit more about the impact of talking about tapering two months ago. They should have pushed back harder as the growing expectations for a change in policy. The data never really supported tapering; I think we were mostly tripping over ourselves (again, myself included) to justify the path toward tapering because Federal Reserve speakers were giving little reason to think otherwise.
UPDATE: One take away from the press conference is that Bernanke thinks markets have a listening problem at least as much as I tend to think he has a communications policy. Fair enough.
Bottom Line: The Fed held steady – ultimately, the data appears to have won. Unfortunately, if the Fed is now concerned about the impact of higher rates, the economy already lost when Bernanke opened the tapering door wide open back in June.
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