Photo: flickr / Medill DC
The Federal Reserve disappointed markets on Wednesday by announcing no new monetary easing measures.In a note to client, BofA rates strategists Priya Misra and Shyam Rajan say the Fed is “waiting for the triple threat”.
Misra and Rajan write that three key triggers must be met before the Fed does any additional easing:
Declining inflation expectations: One of the key justifications of prior QE programs by the Fed was to counter deflationary threats and raise inflation expectations. This time inflation expectations (as TIPS breakevens) have been broadly stable and far from prior lows that were met by Fed actions. While we do not expect the Fed to wait for deflation concerns to pick up, we believe a continued decline in inflation expectations would be necessary before the Fed embarks on further action.
Tightening financial conditions: One measure repeatedly pointed out by Chairman Bernanke is financial conditions. Even at the June press conference, Bernanke pointed out that central banks could help create more accommodative financial conditions and that, “monetary policy still does have some capacity to strengthen the economy by easing financial conditions.” Financial conditions as represented by the Bloomberg Financial conditions index are far from QE1 or QE2 levels. We would closely monitor these conditions as we view them as an important trigger for Fed action.
Risky asset underperformance: While the Fed maintains that it does not react to movements in the stock markets, recent evidence indicates otherwise. Of course, this could be due to an indirect effect of a decline in the stock market adversely affecting inflation expectations and/or financial conditions…changes in the stock market influence financial conditions, making stocks an important trigger to monitor.
What’s next, according to BofA, is that “the market likely will focus on the triggers that might catalyze central banks into action.” They think the conditions will be met by September.