Over at Business Insider we find that Wall Street Journal reporter John Hilsenrath, who seems to be so well-connected to the Fed that it has earned him the nickname “Fed Wire”, has apparently been told that the Fed is discussing the end of its quantitative easing program. As he writes, the “focus is on managing unpredictable market expectations”. In his words, “officials say they plan to reduce the amount of bonds they buy in careful and potentially halting steps, varying their purchases as their confidence about the job market and inflation evolves. The timing on when to start is still being debated.” None of that makes any sense at all. But first things first.
Back in December 2012 the Fed decided to adopt what is generally referred to as an Evan’s Rule, named after Charles Evans, the head of the Federal Reserve Bank of Chicago. The main idea is to signal to the market a clear commitment of providing easy money until some chosen economic indicators fall below (or rise above) a particular threshold value. In particular, the Fed announced it will keep short-term interest rates near zero until either unemployment drops below 6.5% or inflation rises above 2.5%. All this is part of an attempt to include “forward guidance” concepts, a favorite new term of central bankers and monetary economists, into policy making. The point is that there is no “timing” to be debated. The Fed has told us when it will change course: once one of those two goals is achieved. Before that happens, you keep the pedal to the metal (even though current monetary policy falls short of even that, but we’ll leave that for now). The chart below the fold shows that both those indicators are still quite a bit off their marks.
Core inflation, meaning CPI excluding food and energy prices (the measure central banks should and in the case of the Fed indeed do look at), shown in blue and on the left axis, has not reached 2.5% in the past 4 years, and has even started to decline again in the past year. Unemployment, in red and on the right axis, is at least moving in the right direction but is still a full percentage point off target. And what does “the focus is on managing unpredictable market expectations” even mean? The only thing unpredictable about Fed policy in recent months has been how predictable it has become. And that was the whole point of the exercise! Why should the market suddenly expect anything else? Sure, there are questions regarding how the central bank will go about unwinding its quantitative easing program, but until that starts there should be no doubts at all about how the Fed’s monetary policy is going to change, because it isn’t and shouldn’t. Unless the FED plans to end QE3 before the not overly ambitious targets of the Evan’s rule are achieved, which I would argue would be terrible policy.
The article linked to above concludes by stating that “it seems the big moment is finally upon us. The Fed is finally serious enough about starting its “exit” that it is telling Wall Street to get ready”. As far as I can tell, it told Wall Street all it needed to know about its actions going forward back in December. How is this news? And does the market seriously need this kind of hand-holding in order to prevent financial Armageddon from happening? If it does, we’re in even deeper trouble than we had thought.