The Federal Reserve is contemplating unwinding its quantitative easing program, which at $US85 billion in bond buying per month has constituted the single largest provision of marginal liquidity to global financial markets since this latest iteration of the stimulus program was launched in September 2012.
Such a move appears imminent — the consensus in the marketplace is that the first step in tapering back quantitative easing will be announced at the conclusion of the Fed’s September 18-19 FOMC policy meeting.
This prospect has roiled global stock and bond markets in recent months, and in response to the increased volatility, the Fed has sought to reassure investors that it would continue to max out its other (main, in fact) policy stimulus tool — control over the level of benchmark interest rates — for years to come.
In that vein, Goldman Sachs chief economist Jan Hatzius expects the Fed to announce a “dovish taper” at the September meeting. Though the central bank will begin to taper back quantitative easing, Hatzius believes it will also find a way to tweak its “forward guidance” efforts (promises over the future path of interest rates).
The Goldman economist explained a few of the Fed’s options for tweaking forward guidance in a recent note.
And while the Fed is in the spotlight, it’s not the only central bank that is trying to lean more heavily on forward guidance these days — these “open-mouth operations” are currently all the rage at the Bank of England, the European Central Bank, and the Bank of Japan as well.
However, investors don’t think central banks will be successful with these new forward guidance tactics, which are expected to ramp up soon.
“Most clients I met buy our story that the Fed, the Bank of England and the ECB will step up their efforts to push back on expectations of earlier and faster rate hikes in the next few weeks and months,” says Morgan Stanley global head of economics Joachim Fels in a Sunday note. “However, many doubt that Bernanke, Carney, Draghi & Co will be successful in their forward guidance efforts in the face of further improvements in the economic data.”
In other words, despite continued efforts by central banks to keep interest rates low, improving economic conditions will force interest rates up.
For his part, Fels disagrees.
“Too much is at stake for central banks in terms of credibility and there are various ways to make forward guidance more precise and more forceful, including a lowering of the unemployment threshold and/or the introduction of a lower threshold for inflation, below which a rate hike will not be considered,” says the Morgan Stanley economist.
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