As expected, Federal Reserve Chairman Ben Bernanke repeated recent themes in his monetary policy testimony to Congress. However, he appeared to make a clearer distinction between the Fed’s two current policies, emphasizing that short-term interest rates will remain low for a long time. Even though there wasn’t anything new in Bernanke’s testimony, the markets took it as “dovish.” Importantly, the Fed isn’t the only central bank placing an emphasis on forward guidance.
The key points of Bernanke’s testimony:
- There has been no change in the monetary policy outlook.
- If the economy improves as the Fed anticipates (growth picks up, unemployment declines, and inflation moves gradually back toward the Fed’s 2% target), then policymakers expect to begin reducing the rate of asset purchases later this year, and if the economy continues to improve in line with expectations, then the Fed will further reduce the rate of asset purchases in measured steps and end the program in mid-2014.
- Tapering is not tightening.
- The Fed does not expect to begin raising the federal funds target rate until sometime in 2015, well after the asset purchase program ends and economic growth picks up.
Bernanke repeated the notion that the asset purchase program was designed to generate some short-term momentum in the economy – and there’s evidence that it has. Lower long-term interest rates have helped fuel improvement in autos and housing. With momentum in place, the asset purchase program was then expected to be scaled back and more conventional monetary policy (low short-term interest rates) would continue to provide ongoing support to the economy.
The Fed’s message hasn’t really changed over the last several weeks, but the market reaction has. Initially, the taper talk was confused with a tightening in monetary policy. With the Fed’s emphasis on its forward guidance becoming clearer, one would expect long-term interest rates to settle back, and they have to some extent (the 10-year Treasury yield had peaked at 2.75%) – but long-term interest rates are still a lot higher than they were before the taper talk began. The taper talk has led to a reevaluation of risks in the bond market. Fears about excessive risk-taking should have diminished. However, higher intermediate- and long-term interest rates were not the Fed’s intention. An emphasis on the forward guidance should help put further downward pressure on long-term interest rates.
In Q&A, Bernanke said that “we are not talking about tightening monetary policy. I want to emphasize that that none of that implies that monetary policy will be tighter at any time within the foreseeable future.”
The Federal Reserve is not the only central bank giving forward guidance. Indeed, the Fed’s taper talk also boosted interest rates outside the U.S., a move that was not welcome. Minutes of the Bank of England’s monetary policy meeting showed some concern about the rise in interest rates (“…the rise in UK short-term interest rates, which were more reflective of expected policy rates, was surprising. UK developments, while broadly positive, had not been enough to warrant such an upward move in the near-term path of the Bank Rate”). The BOE is considering whether to adopt some form of forward guidance, “including the possible use of intermediate thresholds.” Any announcement on the BOE’s forward guidance will be made on August 7 (after the August 1 policy meeting).
In his press conference following the European Central Bank’s policy meeting on July 1, ECB President Draghi said that “looking ahead, our monetary policy stance will remain accommodative for as long as necessary. The Governing Council expects the key ECB interest rates to remain at present or lower levels for an extended period of time. This expectation is based on the overall subdued outlook for inflation extending into the medium term, given the broad-based weakness in the real economy and subdued monetary dynamics.” Sound familiar? Draghi said the ECB’s move toward forward guidance and the BOE’s decision was a mere coincidence, but both reflected a need to prevent interest rates from rising too rapidly, too soon.
And last week, the Bank of Canada said that “as long as there is significant slack in the Canadian economy, the inflation outlook remains muted, and imbalances in the household sector continue to evolve constructively, the considerable monetary policy stimulus currently in place will remain appropriate.”
In Q&A, Bernanke was pressed repeatedly about whether the Fed would begin tapering at the September meeting. He said that it’s “way too early” to make such a judgment. The Fed’s decision will depend on the economic data between now and then, with an emphasis on a wide range of labor market indicators, not just payrolls and the unemployment rate.
The markets will face another hurdle before the July Employment Report. The advance estimate of 2Q13 GDP growth is due on July 31. There’s always a lot of uncertainty in the advance estimate. Comprehensive benchmark revisions will add another layer of complexity. However, it appears likely that GDP growth was relatively soft (a 1.0-1.5% annual rate), making it a bit tougher for the Fed to taper in September.
The financial markets will have plenty to consider over the next several weeks and the incoming economic data reports will likely get a lot more scrutiny than usual. Better buckle up. It could be a bumpy ride.
© Raymond James
