Fed To Announce Modest QE Tapering In September, Rates To Stay Low For Some Time
While it has been priced in the market that the Fed would announce some sorts of QE tapering in September, the meeting is still worth attention as the amount of tapering remains uncertain and the latest set of economic projections would be released. Consensus suggested that the Fed would reduce its Treasury purchases by USD 10B while some expect the MBS buying would also be reduced. The total monthly purchases would be changed to US$ 70-75B. Another focus is on the forward guidance. Yet, we believe not much change would see as the current one has already done its work in conveying a message that interest rates would remain low even if the unemployment rate drops further.
There are 2 reasons that the Fed would announce some sorts of tapering after the September meeting. First, the job market has shown significant improvement from the same period last year when the Fed raised asset purchases to US$ 85B from US$ 40B. The unemployment rate slipped to 7.3% in August, compared with 8.1% last year. The decline is encouraging although part of the effect was driven by the reduction in participation rate. The 3-month rate of change on nonfarm payrolls is +148K compared to +94K last year. Meanwhile, initial jobless claims have moved to new cyclical lows while some employment surveys have shown rising intention of hiring in coming months.
Second, recent rise in the Treasury market has been driven by speculations of tapering. Policymakers would be concerned about the high volatility of the bond market if it fails to deliver in September. San Francisco Fed President Williams warned that excessive monetary easing might lead to formation of bubbles. At a speech on September, he stated that 'actions, including regulatory and monetary policy measures, may have unintended consequences - such as excessive optimism, risk taking, and the formation of bubbles - that are assumed away in standard rational models'. Williams reiterated that he saw 'normalization of interest rates as a healthy sign'.
The global economic environment has also improved with the risks of a Greece-exit from the Eurozone greatly reduced and peripheral European bonds dropped. The US’ fiscal cliff concern has also been tamed. Policymakers would likely believe that the timing would not be bad for modest tapering of the stimulus.
It is indeed not necessary for fhe forward guidance to be adjusted due to the tapering. The guidance has been flexible enough and succeeded in informing the public that the unemployment rate at 6.5% and the inflation rate of 2.5% would not be 'triggers' of a rate hike, but just guideposts. We expect the Fed to reiterate this stance in September.