The Fed does not want to have its hands tied

The Federal Reserve does not want to have its hands tied. That’s probably the main point to keep in mind from its last monetary policy committee meeting (May the 1st). The central bank does not want to make commitments today that could constrain its behavior in the future. For this the central bank said that depending on the economic situation it could decrease or increase the amount of assets that is purchased every month.

(The US monetary policy relies mainly on two instruments. The first is interest rate. Since 2009, the federal fund interest rate is between 0 and 0.25%. The second is the purchase of financial assets (what is usually called Quantitative Easing). Every month the Federal Reserve buys USA 85bn of financial assets: 45bn of government bonds and 40bn of assets linked to real estate mortgage)

One reason of this move is clearly to change the perspectives on monetary policy. At the last two meetings, there were discussions on the possibility to reduce asset purchases and even to stop this strategy. The main reason was to say that improving economic prospects must have an impact of monetary policy and specifically on Quantitative Easing in order to avoid large imbalances. Ben Bernanke the Fed’s president has ruled out this proposal. If Quantitative Easing is stopped, then there will be expectations that the fed fund interest rate will rapidly creep up. In that case a premium will appear on long term interest rates, reflecting only expectations of higher fed’s rate in the future. If long term interest rates are higher, will the US economy be strong enough to manage that? The fed does not want to take that risk.

At the same time, the Fed does not seem totally convince that the economic momentum is robust. The growth trend is still low at 2% and there is no upside break that could put the US economy on a higher trajectory that would converge rapidly to full employment. The trajectory is not as robust as the Fed could expect. In that case adverse situation cannot be ruled out and the Fed wants to have the ability to move strongly.

Short term uncertainty can be read in the two main statistics that were published at the beginning of May.
The first statistic is the ISM survey. This large scale survey suggests that in March and in April, economy seen from companies’ side has lost momentum. The ISM global index is closer to 50 than at the end of 2012. The economy doesn’t seem able to grow above 2% for a long period of time. The consistency with GDP profile suggests that the situation has not changed recently


The second statistic is the labor report for April. We see on the chart that the private employment profile is not really different this year of what was seen last year and the year before. Investors were anxious before the publication expecting a weak number. That was not the case but the number is still consistent with a 2% growth dynamic. Enthusiasm was probably excessive after the publication.


The Federal Reserve does not want to feed expectations on a strong economy that could rapidly lead to change in monetary policy. That’s the reason of its strategy change. Moreover, inflation rate was just 1% in March (the core rate was also at 1%), well below the 2% that is targeted by the central bank. The accommodative monetary policy can be extended for the future as inflation is too low regarding the 2%. Regarding this target, regarding the risk on economic growth, the Fed has no reason to tie its hands now as it has to remain accommodative still for a very long period of time.