The basics are well known at this point. The Fed extended its expectation for low rate out through the end of 2014, with the new hawk on the FOMC, Richmond Fed President Jeffrey Lacker, dissenting. The growth and inflation forecasts for 2012 were downgraded, while the unemployment forecast was upgraded slightly. Individual forecasts of the path of the Federal Funds rate were revealed, with six participants anticipating interest rate hikes in 2012 or 2013, in contrast to the broader expectation for low rates through 2014. The Fed now has an explicit inflation target of 2%. No new QE at this time.
Some initial thoughts:
First, the forecast for unemployment and inflation, combined with the restatement of the dual mandate with an explicit inflation target, scream for additional QE at this time. This is especially so when you realize the range of 2014 inflation forecasts remains centered on something south of the 2% target. Simply put, the Fed is clearly falling short of both mandates at this point. We need to be patient for the minutes where we can expect to learn more about QE options, and I agree with Calculated Risk that the Chairman paved the way for additional QE, assuming of course that the economy does not show immediate signs of improvement. Still, the delay is frustrating given the forecasts. That said, I think in the last minutes it was clear the Fed was moving in stages, and the communication stage is now complete. Now we can focus on the next round of QE. In addition, most participants would not see a need for immediate action given the improvement in the data flow combined with still stable inflation expectations.
Second, the unemployment forecast appears vulnerable given how quickly the rate decreased in recent months. If the rate of job growth necessary to keep with labor force growth is significantly less than the 125k-150k estimates often used, then I would expect even tepid growth would send the unemployment rate lower than the Fed’s forecast. The Fed is likely expecting a rebound in the labor force participation rates, but is that likely given the tepid growth forecasts? And how much of a decline of unemployment over the next month or two would prompt Bernanke to put a hold on QE3?
Third, I don’t read too much into the divide between the hawks and the doves regarding the timing of a rate increase. That timing is based on each participant’s individual forecasts, with the hawks likely having somewhat more optimistic forecasts for growth and employment compared to the doves. If forecasts disappoint, then the hawks will not be in a position to push for a more aggressive path of tightening. Likewise, the doves will modify their position relative to how their forecasts evolve. Which is why I am looking at that unemployment rate forecast – it seems the most vulnerable.
Bottom Line: The Fed is poised for additional easing, but the next round of QE is not quite a certainty yet. But I think we would need to see some significant upside surprises in the data in the near term to put plans for additional easing on hold. Watch the unemployment rate. We are already at 8.5%, the upper end of the Fed’s forecast. The lower end is just 8.2% – not far away, and something that is plausible at early as next week. The Fed’s forecast just doesn’t feel right given the 0.6 percentage point decline over the past four months.