A stunningly rational Fed decision
Economics in a nutshell: I'm stunned. There is actually a government body that is operating rationally. No, it is not Congress, which seems to believe that political games is much more fun than actually governing responsibly. It is the Federal Reserve.
A stunningly rational Fed decision
September 18, 2013 FOMC Decision
In a Nutshell: "The Committee decided to continue purchasing additional agency mortgage-backed securities … and longer-term Treasury securities"
Rate Decision: Fed funds rate maintained at a range between 0% and 0.25%
Quantitative Easing Decision: Bond purchases remain at $85 billion
I'm stunned. There is actually a government body that is operating rationally. No, it is not Congress, which seems to believe that political games is much more fun than actually governing responsibly. It is the Federal Reserve. The FOMC didn't do what so many had expected them to do: Start to taper. Instead, the Committee reaffirmed its asset purchase policy at least until the next meeting, which is October 29-30. Hooray!
The reasoning for the decision was fairly clear. While the Committee indicated that economic and labor market conditions are improving, the members are still concerned that the unemployment rate is too high. But what really jumped out was the comment that: "the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market". That is a recognition that the recent run-up in rates could have a negative impact on the economy. Since there has not been enough time for those effects to be seen, the FOMC decided that they would wait and watch the data. I think it is also an admission that the huge rise was not foreseen when the Committee decided to start talking about "tapering". I suspect that the Fed's downward revision to 2014 growth was in no small part a consequence of rates rising higher and faster than expected.
The Committee did start the process of warning that even when tapering began, it would not be a straight-line process. I had commented about the need for clear "future guidance" in my report earlier today and the statement was precisely what was expected: "Asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's economic outlook as well as its assessment of the likely efficacy and costs of such purchases." If the data don't show the economy getting better faster, additional asset purchase reductions will be put on hold. That is logical and by starting the education/communication process now, the members will be able to beat that point into the markets' thick heads.
For weeks now I have been saying that I hope the Committee waits to start tapering because economic conditions don't warrant a cut back right now. And indeed, the members are standing pat for all the right reasons: Fiscal policy remains restrictive and in disarray. Interest rates are up and it will take several more months before we get a good idea of the effects on interest-sensitive sectors such as housing. Labor market conditions are still not good with unemployment rates too high and wage gains nonexistent. Inflation remains below desired levels. For all those reasons and probably more, the Fed decided that doing nothing is the best way to proceed right now. I believe that was the right decision to make.
The markets reacted as expected to this unexpected decision. With the Fed continuing to mainline liquidity into the economy, equity markets surged and with the cut back in asset purchases put on hold, longer-term Treasury rates dropped sharply. Now if economic growth would only mirror market changes, all would be right with the world.