All about forward guidance
Ben Bernanke gave a long speech yesterday about the Federal Reserve’s communication of monetary policy. The speech started with a review of the Fed’s actions over the last five years and Bernanke’s desire to make the Fed more open than it was under Alan Greenspan. You can learn a good amount from reading through the entire speech, but investors need to know the likely impact to markets.
The biggest highlight from the speech is the reaffirmation of the 6.5% unemployment threshold. The Fed wants unemployment below that number, and won’t raise rates until it’s comfortably under it. Bernanke stated, “After the unemployment threshold is crossed, many other indicators become relevant to a comprehensive judgment of the health of the labor market, including such measures as payroll employment, labor force participation, and the rates of hiring and separation,” confirming that the 6.5% number is not a simple trigger for tightening. Inflation will play a part too, and with it well below 2%, there’s a good case to be made for continued loose policy.
Asset purchases de-emphasized
Notable in the speech was also Bernanke’s downplaying of asset purchase programs as secondary to forward guidance on the future path of interest rates. I find this interesting, as it appears that QE (quantitative easing) has done most of the work in bringing up asset prices since 2008. Bernanke made clear that QE would end before the Fed starts to raise rates, but again emphasized that the FOMC’s policy decisions would be based on data.
The biggest near-term risk to equities is the timing of the Fed’s reduction of asset purchases (the “taper”). Consensus appears to be for a January taper, so analysts would likely perceive a December taper as a tightening of policy relative to expectations, and bearish for equities.
U.S. stocks (SPY) have been on a great run this year, and whether or not the rally continues is in the Fed’s hands.