Fed starts winding down QE

The FOMC decided to taper asset purchases (as foreshadowed here), although the market reaction was not in keeping with the uncertainty surrounding the announcement. 10 year treasuries were pretty much flat, while equity markets rallied strongly. Precious metals sold off later in the day, while base metals were broadly unchanged.

Most of the attention quickly shifted from the reduction in monthly bond purchased to the accompanying statement which was taken as dovish.  In particular, the FOMC provided very strong wording that they will maintain the "current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent", dependent with the outlook for inflation.

This has been framed as a shift in the Fed's thresholds for tightening and for some offsets the fact they are tapering.

But that isn't strictly true as this is contingent on inflation remaining below target over the forecast horizon. If the inflation outlook changes, so does the likelihood that rates move earlier.

Despite this strong wording, it doesn't really look like any of the FOMC members have changed their outlook for the timing and path of tightening from the September meeting.

The wording in the statement has changed, what they are trying to guide the market towards hasn't.

So in the end, they are not really trying to guide for anything more than what they were expecting 3 months ago.  But what has changed is their confidence in the outlook.

This round of forecasts represent the first in a long time where the balance to next year's estimates look broadly balanced. GDP growth was not revised lower for the first time in quite a while, although inflation projections have dropped a touch.

So what does this mean going forward? The Fed will be pleased that markets are getting the message related to guidance, with the Fed Funds futures not doing too much following the reality of tapering.  While FOMC don't have complete control over the longer-end of the yield curve, it does look to be pretty well anchored even with asset purchases reducing.

This will give them confidence that they can continue to taper asset purchases at forthcoming meetings without disrupting markets too much. Given it looks likely the Fed will hit their forecasts on growth and inflation they should at least be tapering asset purchases by $10 billion in each meeting.

That would bring QE3 to an end in about September.  If anything they seem likely to wind it down a bit faster than that, with June a strong possibility, although at this stage it does not really matter so much.

Given the Fed has loosened its guidance on the unemployment rate, it seems that inflation will now be a much more important consideration for future moves than it has been in the last 12 months.  In some ways they have set the inflation hurdle low for further tapering given "the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings" if the data is in line with expectations. Core PCE rate forecast is only 1.5% in 2014.

But if the FOMC is not increasingly confident that inflation will push towards 2% in 2015, even if growth and unemployment rate forecasts remain unchanged, then they are likely to push guidance for rate hikes out further.