The FOMC Keeps the Momentum Going by Tim McLaughlin
Now that the dust has settled on the Fed’s directive announced last Wednesday in their statement, we want to reiterate several themes. Without a doubt, this is an uber-dovish statement from the Fed.
First, the extended period language was moved out significantly with the first rate hike targeted for late 2014 or later. Granted, this could be pulled back closer over time, but this is the projection as of today.
Second, Bernanke made it clear that the guidance sentence, which is decided by the FOMC voters, dominates the projections, which comes from the whole committee. In other words, the alternate projections, which reference potential hikes in 2012 and/or 2013, should be discounted, as they are dominated by non-voting hawks.
Third, the FOMC has quietly raised its inflation target. Just five years ago the discussion was about a 1 to 2% range, and then it moved to 1 1/2 to 2%, then 1.7 to 2% and now simply 2%. Clearly the Fed is worried about running a low target because it means that during recessions there is a greater risk of either going into deflation or hitting the zero lower bound on interest rates. Hence, create a bigger cushion gives more room for fluctuation.
Fourth, the Fed has implicitly changed the weights in its “Taylor Rule”. By law the Fed is supposed to put equal weight on unemployment and inflation, but since Volcker came in the implicit sense was that inflation had a bit more weight. This does not mean the Fed has given up on controlling inflation, but, rather, it does mean on the margin they accept bigger cyclical swings in inflation.
Takeaways – All of this suggests:
(1) The first rate hike will come even later
(2) Even stronger odds of QE3 (focused on MBS given Fed’s focus on housing) after the “Twist” is over and if growth weakens as most expect
(3) Somewhat higher inflation and inflation expectations
(4) More inflation volatility
(5) Accommodations to support the broader economy, lending (and housing as a bi-product) and investment (corporate and otherwise).
All in all, more positive news to support the market in 2012.
