By Kasra Kangarloo
WASHINGTON (MNI) – The consensus among economists regarding the latest
decision of the Federal Open Market Committee is something of a paradox: nothing
has changed, and yet everything has changed.
“The decision doesn’t really actually alter the policy, it doesn’t mean the
committee is a lot more likely to raise rates sooner or later than previously,”
Paul Dales, economist at Capital Economics, told MNI, referring to the decision
as “window dressing.”
The FOMC made two major policy changes in Wednesday’s statement: purchases
in the “operation twist” program, which will end this year, will be replaced
dollar-for-dollar by $45 billion in open-ended monthly purchases of long-term
Treasuries. Forward guidance for the federal funds rate will also be based on
the unemployment rate and inflation, as opposed to a calendar date, with some
explicit wiggle room allowed for higher inflation in the medium term.
The former was more or less expected by markets; the latter was a surprise
largely because of the timing, as the change in guidance for the federal funds
rate has been under discussion for some time by the committee, and was expected
sometime next year.
“It just provides more color or clarification on the conditions that would
prompt the committee to change policy,” Dales said.
The flip-side, as Dales noted, is that markets will now put a great deal of
weight on the evolution of the unemployment rate and other related economic
data. Economists interviewed by MNI concurred that this was more or less the
Prior to yesterday’s move, the market effect of changes in economic data
was somewhat buffered by the calendar-based guidance on interest rates,
according to Dana Saporta, economist at Credit Suisse.
“If data came in stronger or weaker than expected the reaction was
suppressed by the fact that there was this calendar date guidance out there,”
Saporta told MNI. “But now if data comes in stronger than expected, that would
pull in market expectations of Fed tightening.”
“I think the Fed thought this was one of the benefits,” she added.
Ultimately, this new market environment is one in which short-term
volatility can be greatly increased, as the release of economic indicators with
any relation to the jobless rate will now be shaded by the possibility of new
actions from the Federal Reserve, according to Saporta.
She also noted that over the longer term, the clarity of the FOMC’s
intentions should smooth out the trajectory of the market.
“What this new policy does is potentially promote more volatility in
trading in response to economic data surprises,” Saporta said.
Sean Incremona, economist at 4Cast Ltd., said the explicit link to the
unemployment rate could also pose certain problems, as the figure not only
relies on the changes in employment but also on the labor-force participation
This could prove to be a communication challenge, Incremona said, due to
the possibility that the unemployment rate will drop despite net job losses.
As an example, the unemployment rate dipped to 7.7% in November, the lowest
level since December 2008, even as net employment decreased.
The previous month showed the same situation in reverse: because the
participation rate rose more than the increase in employment, the unemployment
rate ticked up to 7.9% despite the net gain in jobs.
“There’s still a lot of uncertainty in communication impediments that go
along with [the unemployment] threshold,” Incremona said.
Saporta noted, however, that the wording of the guidance should allow
enough room for the Fed to make exceptions in unusual cases.
“I think the way the guidance was stated gives them plenty of leeway,” she
said. “It doesn’t tie their hands, which is appropriate because monetary policy
can’t be distilled into just a couple of variables.”
Federal Reserve Chairman Ben Bernanke made a similar point in his prepared
remarks for Wednesday’s press conference. He warned that, “reaching one of those
thresholds … will not automatically trigger immediate reduction in policy
Both Saporta and Incremona also noted that the change does not necessarily
reflect a more dovish stance as relates to inflation, even though the new
guidance allows explicitly for increased flexibility regarding inflation in the
“Overall what they did [Wednesday] was theoretically keeping policy
unchanged,” Incremona said. “It just now allows for increased flexibility and
sensitivity to economic developments as we move forward.”
–Kasra Kangarloo is a reporter for Need to Know News
–MNI Washington Bureau; tel: +1 202-371-2121; email: firstname.lastname@example.org