US: Open-mouth Operations at Work

US: Open-mouth Operations at Work

Yelena Shulyatyeva and Bricklin Dwyer

Chairman Bernanke stuck very close to the party line during his conversation today at the University of Michigan, and did not alter or deviate from that message. When given the chance to push back on the market's response to the December FOMC minutes, he didn't. Unlike some of the FOMC participants we heard from yesterday, Chairman Bernanke did not provide any guidance on the timing of asset purchases. In our view, he is likely in the camp of FOMC members who “emphasized the need for considerable policy accommodation but did not state a specific time frame or total for purchases.” The Chairman said that QE has been effective in the past and that the latest round looks like it is working, but cautioned that it is too early to make an assessment. He still sees the labour market as weak, the economy as fragile and the cost of letting unemployment persist at current levels enormous. He reiterated two main tools are at the Committee's disposal: forward guidance, otherwise known as “open-mouth operations,” and QE. Going forward, the FOMC will need to consider how effective these policies are and evaluate their costs and benefits.

Fed President Charles Evans, the most dovish member of the FOMC, is also likely in the camp of FOMC members who “emphasized the need for considerable policy accommodation but did not state a specific time frame or total for purchases.” Responding to questions after his remarks, he said that “if the U.S. adds 200k jobs per month for several months, that would be an indicator that the Fed could end asset purchases in line with its pledge to continue until it sees “substantial improvement” in labor markets.....That’s going to be on the order of 1 million to 1.5 million jobs over the next six months to a year. That would be indicative that we could stop.” Payrolls have been very stable as of late running at 150k to 160k, still falling short of the “substantial and sustainable” improvement. Our forecast suggests payrolls growth will slow somewhat from its current pace as a consequence of the fiscal tightening and heightened uncertainty about the “debt ceiling” and will not hit a 200k pace until mid-2014. This supports our view that asset purchases will continue until mid-2014.

Fed Presidents Lockhart and Williams, who rotated off as voting members this year, also provided their views on the economy and monetary policy. President Lockhart, in a more hawkish speech, emphasized concerns about financial stability and market functioning. President Williams suggested that the FOMC “will be looking for convincing signs of ongoing improvement in the labor market and a range of other economic indicators before [they] stop this program. [He] anticipate[d] that continued purchases of mortgage-backed securities and longer-term Treasury securities will be needed well into the second half of 2013.” While this puts President Williams in the camp that “expressed the view that ongoing asset purchases would likely be warranted until about the end of 2013,” it is conditional on his forecast for economic growth to accelerate to 2.5% in 2013 from his expectation of 1 ¾% for 2012. We anticipate growth to remain below 2% this year, which is also a factor driving our view on asset purchases.

Both Presidents Williams and Lockhart stressed the harm uncertainty has had on the economic recovery. President Lockhart noted that in 2012 “the most potent restraint on growth was wariness born of uncertainty.” President Williams noted that “the budget mess in the United States, questions about taxes and health-care reform – these and other factors have combined to undermine the confidence of Americans…In a pattern reminiscent of the debt ceiling debate in the summer of 2011, the recent rise in uncertainty has been accompanied by a sharp drop-off in business and consumer confidence.”

Unfortunately for the US, uncertainty continues to brew. President Obama warned Congress, once again, that he is not willing to negotiate over the debt ceiling. The president reiterated that it is Congress’ responsibility to pay its debts and if they do not want that responsibility, he will take it. Meanwhile, Democratic leaders sent a letter to the president encouraging him to use "any lawful steps" to avoid a default. This is likely a reference to the president's ability to invoke the 14th Amendment, which states that the obligations of the US government shall not be questioned, and the Treasury should issue debt, despite breaching the debt ceiling. Such a move would be highly contentious and would come with significant costs, but it cannot be ruled out as a method to avoid an imminent default at the 12th hour. In the meantime, the president is trying to capitalize on his current post-election popularity, which faded fast after his first election.