The Fed's Policy Timeline

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by: Evan Schnidman

The release of the March FOMC Minutes has brought renewed discussion of when the Fed will slow and eventually halt their asset purchases. The minutes suggest that given improving economic conditions, several members were in favor of curtailing asset purchases immediately or by midyear with purchases ending by the close of 2013:

In light of the current review of benefits and costs, one member judged that the pace of purchases should ideally be slowed immediately. A few members felt that the risks and costs of purchases, along with the improved outlook since last fall, would likely make a reduction in the pace of purchases appropriate around midyear, with purchases ending later this year. Several others thought that if the outlook for labor market conditions improved as anticipated, it would probably be appropriate to slow purchases later in the year and to stop them by year-end.

It is important to note that this assessment was based on the assumption that labor market conditions would continue to "improve as anticipated." Since this meeting was held before the dismal March employment report, it is reasonable to assume that these "several" members are probably a bit more wary of unwinding QE by year-end. Perhaps more importantly, there is no guarantee that the members looking to curtail asset purchases are voting members on the FOMC this year. If anything, it is most likely that they are the hawkish members that will occupy the FOMC in 2014.

In addition to those discussing the imminent end to QE, two members suggested asset purchases continue at their current pace until year-end and raised the possibility of increasing asset purchases if economic conditions deteriorate. The weak March employment report probably does not qualify as sufficient deterioration, but that compounded with continued talk of fiscal austerity and weakness in Europe definitely creates significant headwinds for the U.S. economy. This leads me to continue targeting September as the most likely time to see the beginning of QE reductions. The March minutes suggest a several month timeline for staging down QE, so I anticipate the conclusion of QE3 in the first quarter of 2014.

Given that the Fed's forward guidance holds them to employment and inflation targets that are unlikely to be met before 2015, this timeline means that the remainder of 2014 looks likely to be very quiet on the monetary policy front, unless the economy dramatically backslides or remarkably recovers. This period of calm may serve as a time in which the FOMC would consider experimenting with nominal GDP targeting that has been in the news lately. While this rule would be a dramatic departure from the ad hoc monetary policy we have had over the last few years, I do not believe that this type of certainty would necessarily result in better policy outcomes and I suspect several members of the FOMC are equally dubious.

Aside from the unlikely steps toward nominal GDP targeting by the Fed, one interesting and unexpected change in upcoming Fed policy was signaled by Chairman Bernanke this week. During the question and answer session after a speech about bank stress testing the Chairman suggested that the Fed will raise rates on excess bank reserves as a means for tightening monetary policy, rather than unwinding the Fed's $3 Trillion balance sheet. This policy coupled with increased capital requirements suggests that bank profits will drop over the next few years, making bank stocks a good long-term short. In the shorter term investors can look to time a broader market correction when the Fed initiates the process to allow QE3 to "taper off."

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.