Fed comfort with impact of higher rates keeps tapering firmly in view

The latest statement from the FOMC wasn't hugely different from September, suggesting to the market that tapering of bond purchases in the not too distant future is more of a possibility than the market was anticipating.

It does seem that Fed is less concerned about the current level of interest rates than they were back in September, with the telling removal the statement that "the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market" seen last month

10 year Treasuries have rallied since the September meeting to ~2.5%, with mortgage rates also falling around 30bps.  This seems to be where the Fed wants rates to be, with the FOMC likely to be encouraged by the fact they have been able to curb the rapid sell-off in bonds seen mid-year.

It also appears that the FOMC is comfortable with the impact of rising interest rates thus far.  The biggest concern would have centred around what rising mortgage rates would have meant for the housing market, but there is no great alarm here, with "the recovery in the housing sector slowed somewhat in recent months."

New home sales are one of the better guides here and they have been notably weaker in the last 2 months.  But perhaps the FOMC is yet to be convinced this will be persistent.

While no members on the FOMC would have seriously pushed for tapering at the October meeting (with hawks on the committee recently commenting they wanted to wait), the lack in the change in the wording of the statement suggests that once December rolls around they will be as close to tapering as they were in September.

But as has been the case all year, it will largely come down to how the data progresses relative to expectations.  As the table on the left shows, information since the September meeting has been dovish, notwithstanding the uncertainty generated by Government shutdown earlier this month.

That said, it does appear that the Fed is continuously lowering the bar for what is required for bond purchases to be scaled back.  The projections accompanying the last statement showed forecasts were lowered, but they were still willing to entertain changing policy.

It seems likely that by the December rolls around that projections for growth will have to be lowered yet again.  But given that this most recent statement is if anything a bit more hawkish, it seems the decision to taper bond purchases will be a close call.