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Fixed-Income Insights

A Federal Reserve official raised the possibility that the central bank could extend its quantitative easing program. Here’s why that is not likely to happen. 

 

In Brief

  • Amid renewed financial-market volatility, St. Louis Federal Reserve Bank President James Bullard recently suggested the Fed might consider extending its bond-buying program beyond October.

  • But no other Fed official has expressed a similar view. In fact, recent statements from Fed members have emphasized that the central bank is ready to end quantitative easing (QE).

  • It appears that market volatility will have little impact on upcoming Fed policy decisions, as projections for U.S. economic growth remain intact.

  • The key takeaway—As QE ends, markets will zero in on upcoming Fed policy statements, specifically as to whether policymakers will change language surrounding the timing of future interest-rate hikes.

 

Could the U.S. Federal Reserve’s quantitative easing (QE) program stick around past Halloween? Comments by St. Louis Federal Reserve Bank President, James Bullard, on October 16, 2014, suggested the Fed might consider extending its bond-buying program beyond October.  “Inflation expectations are declining…a logical response at this juncture may be to delay the end of the QE,” he said in an interview with Bloomberg News.1  Bullard’s comments helped erase stock market losses that day, and helped reverse a rise in prices on U.S. Treasury securities, as investors responded to the hope that additional Fed action would support risk assets and stem the “flight-to-quality” rally in Treasuries. 

Despite the calming impact of Bullard’s comments, no other Fed official has expressed a similar view. This suggests that other Fed officials thought the recent market volatility did not require further comment from the central bank. Charles Plosser, president of the Federal Reserve Bank of Philadelphia, and   Narayana Kocherlakota, Minneapolis Fed president, also spoke publicly on October 16, without suggesting a shift in QE or policy expectations. Similarly, on the following day, Friday, October 17, speeches by both John Williams, president of the Federal Reserve Bank of San Francisco, and Federal Reserve chairperson Janet Yellen included no suggestion that recent global economic developments, inflation expectations, or market volatility would change QE or overall monetary policy. 

The Wall Street Journal reported in an interview on Saturday, October 18, that Boston Fed president Eric Rosengren said the Federal Reserve is ready to end its bond-buying program at its meeting on October 28–29, 2014.2  It is worth noting also that Bullard, while a highly respected and influential member of the Fed, does not vote on policy this year.  

Little Policy Impact
The absence of commentary surrounding the fate of QE, especially since Bullard’s comments caught the attention of financial media—and markets—suggests that an extension of QE will not be foremost on the Fed’s agenda at its October meeting. While observers can’t help but wonder if the recent market volatility and its underlying causes may have influenced expectations for broader monetary policy, the lack of commentary by Fed officials would suggest not. 

Rosengren said in the October 18 Wall Street Journal interview that “I haven’t changed my own forecasts based on a week or two of volatility in financial markets.” In a similar vein, the San Francisco Fed’s Williams told the Journal in an October 19 interview: “I don’t think there’s really been any important economic news, or economic development that would cause me, based on the last few weeks, to shift my view on the outlook for the U.S. economy.”3 In a more specific reference to concerns about Eurozone weakness and other global situations, Williams said: “International developments have not been significant enough to move (my forecast) in a really meaningful way.” 

Fed expectations for economic growth of around 3% for the balance of 2014 and for 2015 also are seemingly unaffected by recent volatility and investor concern about slower global growth. In that 3%-growth environment, inflation is generally expected to rise back up to the central bank’s 2% target within the next two years or so. Yellen, Plosser, and Williams all cited the combination of 3% growth and 2% inflation in recent remarks. Similarly, Rosengren was “expecting a little less than 3% growth over the next year and a half…” with inflation drifting up to 2%. Kocherlakota does not expect inflation to rise to 2% until 2018.

Surprisingly though, Bullard also expects gross domestic product (GDP) growth of 3% over the balance of 2014 and 2015. In fact, in his October 16 interview with Bloomberg News, he continued to forecast the first Fed interest-rate increase at the end of the first quarter of 2015 based on the expectation that the current global market turmoil will not affect U.S. prospects. Most other comments from Fed officials have cited mid-year 2015 as the most likely time for an initial interest-rate hike. 

So if recent commentary from Fed officials is indicative of the perceptions of the policy-setting Federal Open Market Committee, it should not be surprising to see QE come to an end at the October 28-29 FOMC meeting, along with a Fed statement that reinforces expectations that the first planned hike in the fed funds rate is expected toward the middle of 2015. 

A "Considerable" Change?
That said, Fed watchers will be looking for some additional signals in the October policy statement. For some time now, the Fed has stated that the current target range of the fed funds rate would be held at 0-0.25% for a “considerable time.”  The mid-October speeches by Fed members included clues that there may be increased interest in changing the language to indicate that any potential policy tightening will be “data dependent” instead. The Philadelphia Fed’s Plosser, who objected to forward guidance that focused on basing an increase in the fed funds rate on a timetable rather than on available economic data at the last two FOMC meetings, reiterated his concern in his October 16 speech.  He pointed out that “interest rates may begin to increase sooner than previously anticipated” and that changing the Fed’s policy language would be “the appropriate first step” in the process of adjusting policy to economic conditions.4 If altering Fed policy language is a first step in the path of rising rates, Plosser can likely expect support for such a move from fellow hawks, Dallas Fed president Richard Fisher and Cleveland Fed president Loretta Mester, both voting members.

Similarly, though Bullard is not a voting member this year, his expectation of the first funds-rate increase in the first quarter of 2015, implies support for a change to the phrase “considerable time.” Rosengren pointed out in his Journal interview that changing expectations of market participants due to economic or market volatility “highlights why calendar guidance is not the way to go.” His comments preface the upcoming FOMC meeting and the discussion that may unfold. “[W]e’ll have to think about exactly what’s the appropriate wording…given the volatility we’ve seen in markets,” he told the Journal

Given the views of several FOMC participants, the discussion surrounding language of the policy statement on October 29 could be contentious. The outcome is not guaranteed. Two dissenting votes at the September FOMC meeting—a relatively rare occurrence—combined with increased public discussion of a potential policy-language change suggests that October may be the meeting where the “considerable time” phrase is modified. On the other hand, a change could be postponed until the next FOMC meeting in December, which is scheduled to be followed by a press conference with Yellen, which would give the Fed chief an opportunity to elucidate any potential change.

A final consideration is the shift in FOMC membership composition in January. For 2015, the hawks Plosser, Fisher, and Mester, and the dovish Kocherlakota, will be replaced by Williams and Chicago Fed president Charles Evans, both doves; and Atlanta Fed President Dennis Lockhart, a centrist. Of course, the Fed could decide to defer a decision on the language concerning a rate-hike timetable. Rest assured that there will be a “considerable” amount of attention paid to the matter as 2015 dawns.       

 

Steve Matthews and Craig Torres, “Bullard Says Fed Should Consider Delay in Ending QE,” Bloomberg, October 16, 2014.
Pedro Nicolaci da Costa, “Fed to End Bond Buys This Month as Planned, Says Rosengren,” The Wall Street Journal, October 18, 2014.
Jon Hilsenrath, “A Q&A With San Francisco Fed’s John Williams,” The Wall Street Journal, October 19, 2014.
Charles K. Plosser, “The Economic Outlook and Monetary Policy,” Federal Reserve Bank of Philadelphia, October 16, 2014.

 

ABOUT THE STRATEGIST

More on the Fed

 

videoZane Brown examines how U.S. fixed-income categories could potentially respond to two rate-hike outcomes from the Federal Reserve.

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