By Keith Wade
The Fed finally took the plunge and decided to trim asset purchases to $75bn per month, a reduction of $10bn evenly split between Treasuries and mortgage-backed securities. The action will take effect from January. In addition the central bank enhanced their forward guidance on rates by stating that the current target rate for the Fed funds is likely to be maintained “well past the time when the unemployment rate falls below 6.5%, especially if projected inflation continues to run below the Committee’s 2% goal”.
The majority of Fed officials do not see rate rises until 2015, whilst three do not expect a move until 2016. This is about as dovish a taper as could be imagined. However, on the basis that the Fed trims $10bn at each subsequent meeting, asset purchases would be over by October next year. At his press conference Bernanke dutifully reminded us that such moves were data dependent and left the impression that the Fed still has doubts about the strength of the recovery and concerns over the low inflation level.
Inflation certainly is low, but it is a lagging indicator. There are already signs that wages are responding to the fall in unemployment and as the labour market tightens further, which leading indicators suggest it will, price pressures will pick up.
Compared to the Fed’s projections we also see more upside risks to growth in 2014 as there is scope for a stronger consumer as employment and incomes rise and wealth effects continue to improve balance sheets and confidence. Those wealth effects got a little stronger as markets soared on the taper news. The economy is approaching take off velocity in our view.
Bernanke has every right to be cautious after the experience of the past few years, but there was an opportunity here to herald a turn in the economy and a new phase of growth. Instead of dispensing seasonal cheer he seems stuck in crisis mode.
Keith Wade is chief economist at Schroders
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