After the major re-write of the FOMC statement at September meeting the text of this afternoon's release contains comparatively few changes, reflecting the fact that the decision to defer any reduction in bond purchases last month was always likely to be a multi-month affair. In addition the government shutdown meant somewhat less official data was available for perusal and those reports that were released were (even) less reliable than normal.
We have attached a red-lined version of the text (courtesy of Bloomberg ©) and as can be seen the majority of changes take place at the start of the communique. The outlook for the housing market was downgraded a little but perhaps the most interesting linguistic choice was to remove the controversial reference to the "tightening of financial conditions" as a risk to the recovery that was included last month.
There were three explanations offered by observers to the use of this term last month:
1. Ignorance
2. Conflation of Financial Conditions with the general level of interest rates (we note that the Chicago Fed's Financial Conditions Index contains a large input from underlying interest rates see link http://www.chicagofed.org/webpages/research/data/nfci/background.cfm ).
3. An implicit signal that the FOMC had been influenced by the (genuine) deterioration of financial conditions in a number of key emerging markets.
If we remove #1 as both impolite and highly unlikely given the large number of FRB staff who are paid to sit around looking at data, the remaining two explanations (which are not mutually exclusive) do offer an insight into the degree of the task that the FOMC has taken upon itself.
Over-emphasizing the significance of treasury yields removes the concept of a "benign" rise in interest rates, with no differentiation being made between a rise in treasury yields that steepens the curve and compresses credit spreads (even if nominal credit yields still rise), and one which is driven either by a sharp increase in short term yields and flattens the curve, or a rise of credit yields in which treasury yields either remain the same or actually decline. The first scenario is actually the typical back-drop for a strong economic recovery, the second for the period in which a central bank is adjusting policy to bring it into line with reality and the third a sign that monetary conditions are inappropriately tight. Under the Bernanke Doctrine instead we have a steadily strengthening economy with depression level treasury yields and relatively high credit spreads.
Regarding the influence of events within emerging markets we note that the extension of the FOMC's mandate into the international sphere arguably commenced in 2008 with the launch of the CBLS (a large scale provision of USD swap lines to a number of key EM central banks) and that this facility was used on a smaller scale in late 2011 to help the ECB control USD pricing at the height of the Eurocrisis. Nothing as dramatic took place over the summer months but the notion that the decision to maintain full bond purchases because of the stresses encountered in countries such as India and Brazil is somewhat surprising. Nevertheless the strains felt in financial conditions of emerging markets were clearly discussed in the truncated minutes of the September meeting and our assumption is that they were a factor in the decision to keep the current level of bond purchases in effect.
The removal of this language regarding financial conditions may therefore be an indication that the FOMC received some criticism over this issue or may instead reflect the fact that interest rates came back down in the US and most emerging markets have recovered a good portion of their summer losses. However, the fact that they did not choose to state that financial conditions have recovered but instead simply deleted the reference to them makes the former explanation a little more likely.
The rest of the text remains almost unchanged, with the promise that bond purchases will remain in place for a while longer and that the gap between tapering and an actual rise in interest rates will be lengthy. We continue to take issue with the latter, since we believe that the FOMC continues to underestimate both the speed with which employment conditions are improving and inflationary pressures are building. We do not doubt the honesty of the committee, merely its ability to accurately gauge the trajectory of an economic cycle which has consistently surprised it.
FOMC Statement Oct 30th 2013