US monetary policy: time for ‘measured’ tapering

by George Hatjoullis

image001The  markets continue to feel anxiety at the prospect of the Federal Reserve of the USA ‘tapering’ its asset purchases. Parallels with 1994 are drawn and are discussed in my previous blog. The parallel has merit in that the conditions for an ugly bond bear market and market failure are certainly in place. However, in some respects the parallel is misplaced. In February 1994, the Fed surprised the market and this caused chaos. It can hardly be accused of surprising the market now.

Perhaps the more pertinent parallel is provided by the minutes of the Fed meeting of May 4, 2004. The minutes concluded:

At this juncture, with inflation quite low and resource use slack, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.”  (

At the next meeting the Fed raised the federal funds rate by 25 bp to 1.25%. The two-year Treasury note yield had already begun to rise in 2003 as the language of the Fed has slowly turned from keeping rates low for a ‘considerable period’ to being ‘patient’ with its accommodative policy. The use of ‘measured’ signalled the pending rate increase and the intention to raise rates at a steady and predictable pace. The two-year Treasury note yield rose to over 5% by 2007, yet no one speaks of a traumatic bond market meltdown over this period. In fact the whole period was characterised by declining volatility and a bull market in equity and credit products. The fact that it laid the foundations for the financial crisis that began in the second half of 2007 is quite another story.

The Fed minutes that followed May 2004 were characterised by the ‘measured’ phrase. This phrase, and all that it implied, allowed a 425 bp increase in Fed Funds without the equity and credit markets flinching. Bonds were in a bear phase but it was orderly. This does not mean the fed can repeat the trick or indeed, given what happened after 2007, that we should want them to do so. Nevertheless it does illustrate that it is possible to go from 1% federal funds to 5.25% without a market or economic catastrophe.

Just a thought.