Dollar Dithers As QE Withers

The US dollar is narrowly mixed in quiet turnover.  The historic FOMC meeting that announces the end of QE is finally at hand.  This marks a new phase, post-QE, for monetary policy, and the US economy more broadly.  

 

Although there had been some jitters, investors have come around to expect the Federal Reserve to announce its commitment to end QE today. Not ending QE would potentially be more disruptive than ending it.  

It will complete the strategy announced by Bernanke before his term ended.  Up until now, Yellen has been executing the strategy, and neither the contraction in Q1 nor the strong jobs growth was sufficient to get her to alter course. Going forward, this is Yellen’s Fed in a different way.  

The statement is the most important of the Fed’s communication tools.  It is written or driven by the chair.  We argue Yellen is part of a triumvirate that drives Fed policy, and include Fischer and Dudley.  From them, the policy signal emerge.   

We expect today’s statement to reflect that this centrist core remains in control. That means the continued use to three word cues:  the “significant under-utilization” of the labor market, the “considerable” period between the end of QE and the first hike, and that the Fed funds rate may remain below what is regard as the long-term equilibrium level.  

Perhaps the most interesting part of the statement may be how the Fed addresses the decline in market-based measures of inflation expectations. This part has potential to surprise investors.  If the topic is played down, or not even addressed, investors may feel more confident of a rate hike in the middle of next year, as Dudley, and others, have indicated is a reasonable scenario.  To the extent that the Fed expresses concern, it may encourage investors to continue to push out the first hike.  

At most, a bland reference to monitoring inflation expectations as expressed through various channels, may be expected. The underlying principle in both the statement’s forward guidance and its reference to inflation expectations is that without QE, communication maybe even more important. And to that end, whatever significant changes may be necessary, barring great urgency, can best be delivered when the Chair holds a press conference to help investors understand.