FOMC - QE Tapering Is Drawing Closer‏

The latest comments from key members of the FOMC, combined with a hawkish twist in this evening’s FOMC minutes, suggest that a scaling-down of asset purchases is moving closer. We have so far stuck to our call that tapering will start at the December meeting, but the chance of a move as early as the September meeting has increased markedly.

The message from Bernanke’s testimony before Congress today remains that QE tapering is dependent on labour market conditions, especially job growth over the coming months. In the Q&A session, Bernanke stated that tapering ‘could’ begin in the ‘next few meetings’ although he noted this was conditional on a sustainable improvement in the labour market.

The first tightening of monetary policy is however still far away. It is important to distinguish between ending QE – which in Bernanke’s view is not a tightening of policy as long as the Fed’s balance sheet remains constant – and hiking the Fed funds rate. The latter is what Bernanke refers to when he talks about tightening policy and here the message is still dovish.

The minutes from the April/May FOMC meeting add further to the sense that QE tapering could come as early as September:

“Most observed that the outlook for the labor market had shown progress since the program was started in September, but many of these participants indicated that continued progress, more confidence in the outlook, or diminished downside risks would be required before slowing the pace of purchases would become appropriate. A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome. One participant preferred to begin decreasing the rate of purchases immediately, while another participant preferred to add more monetary accommodation at the current meeting and mentioned that the Committee had several other tools it could potentially use to do so.”

In September we will have received another four employment reports to assess the improvement in the labour market. If these continue, on average, to show job growth on the right side of 200,000 per month, it seems that a gradual tapering of QE could start following the mid-September FOMC meeting. We do expect economic growth to pick up during H2 this year and thus expect a continued improvement in the labour market. This favours scaling down QE at the September meeting but payroll data is notoriously volatile, so we could not be 100% certain on September.

One caveat is inflation. Although neither Bernanke nor Dudley expressed much concern over the low inflation rate, the minutes nevertheless strike a more worried tone. In particular, “a number of participants expressed concern that inflation was below the Committee’s target and stressed that future price developments bore careful watching and a couple of participants expressed the view that an additional monetary policy response might be warranted should inflation fall further.”

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