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Investors will be focusing on any taper talk in the minutes from the July 30th/31st FOMC meeting released later this afternoon. The million-dollar question is will there be anything new on the topic? FOMC members have been indicating that the” usefulness of asset purchases (QE3) is declining while the costs are rising.” That would suggest that the timing for the Fed to begin taking their "foot of the gas pedal" is nearly upon us. What other actions might U.S. policy makers take in combination with a tapering of their $85b-a-month asset purchases?

“Helicopter” Ben Bernanke has been highlighting an impending “shift in the mix of accommodation” for the past several months and the minutes from the June meeting indicate that there was a preliminary discussion of potential changes in "rate" guidance. Ever since then, a larger percentage of the street has been talking about a shift in the mix options. The options under consideration include the reduction in the unemployment rate threshold from +6.5% to +6%, and the introduction of a new downside inflation threshold. For many, a new inflation threshold is the least controversial step. Some dealers on the street foresee the Fed taking such a step coupled with a modest tapering move at next month's FOMC meeting – they will be looking in the minutes for such a scenario to happen.

In the June post-FOMC press conference, the market appeared to take the view that Bernanke seemed generally supportive of a reduction in the unemployment rate threshold to +6% (+7.4%). The fixed income dealers have noted that “if the rate guidance were not conditional, such a change would imply about a 9-month delay in the first rate hike.” However, some rather large assumptions would have to be included – like a monthly payroll growth of +200k. Consistent job growth to date has been difficult; just like the participation rate that is currently hovering near its three year low of +63.4%. Some have argued that the rate guidance is too highly conditional. If that is the case, then perhaps there is little difference between a +6.5% and a +6% threshold. The rate market has indicated that under a certain set of economic circumstances, the first rate hike could occur at +6.25% regardless of whether the specified threshold was +6% or +6.5% – the unemployment rate guidance is clearly specified as “conditional.”

For many, a less controversial option for the FOMC would be the introduction of a new +1.5% downside inflation threshold. The market could interpret this as “a wholly symbolic attempt to drive home the message that a tapering of asset-purchases does not have any implications for timing of future rate hikes.” It’s been described as symbolic, because it would never naturally impede any future tightening by the Fed. Would Ben and his fellow cohorts ever consider a rate hike when projecting that next year’s inflation rate will be “below” 1.5%? It’s certainly a mouthful, and historically a non-starter to the better informed who insist that rate hikes would ever be given “serious consideration under such an inflation outlook.” In theory, this suggestion is anything but symbolic – no practical significance.

The fixed income market will also be looking for any hints regarding the composition of asset purchases once tapering begins. Will it be a balanced winding down of Treasuries and mortgage backed securities (MBS)? The hawks want the Fed to reduce MBS buying as soon as possible. However, they are up against it as the recent FOMC announcement suggests that MBS will never be sold.

Do not be surprised to see the Fed try and appease Bullard and get him to drop his dissent by some discussion surrounding the July statement referencing disinflation concerns. In the minutes, a reference of the potential impact of rising mortgage rates may also be inserted. These topics and the changes in rate guidance would probably keep the “doves” happy.

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