Regaining the initiative in Federal Reserve monetary policy

by George Hatjoullis

USA Unemployment rate

In a previous blog [ The S&P 500 and the Goldilocks Taper narrative] I suggested that only by initiating the taper can the Federal Reserve regain the initiative. It would appear that James Bullard of the St Louis Fed might agree with this conclusion. In a presentation made known to me by my friends at KGM Capital, James Bullard makes two notable observations. First, tapering is data dependent and specifically unemployment data. The presentation ( provides a chart that suggests unemployment is on a sustainable downward path. Second, the Fed is concerned that the market is linking forward guidance on interest rate policy with the pace of QE. The Fed regards these as independent policy tools. What does this mean in practice?

The initiation of tapering fear sent the forward yield curve higher. The market set forward interest rates higher than the Fed wished and was indicating it planned via forward guidance. The Fed wishes to start to scale back QE without initiating such a rise in forward interest rates. In the mind of the Fed this is possible but is being thwarted by the insistence of the market in linking two independent policy tools. James Bullard is quite clear:

While changing the pace of asset purchases acts very much like a
conventional change in interest rates, this effect also spilled over to
the expected path of the policy rate, the Committee’s “forward

This effect was perhaps surprising in the view of policymakers, who
view the two tools as independent, but not in the view of financial
markets, which view the two tools as tied closely together.

He concludes:

The Committee is using two different policy tools—asset
purchases and forward guidance—which it views as
independent, but which are viewed as closely linked by
financial markets.
 This presents challenges for the Committee.

Indeed it does and it, rather than data, is probably why the taper has been delayed. The reality is that market will always link the two. The only way to diminish the consequences for the forward curve is, ironically, to initiate a taper. This would then allow the Fed to signal to the market, through the size and frequency of variation in asset purchases, the importance and invariance of its forward guidance. Once the taper is out of the way its significance would diminish and the forward guidance would dominate the forward yield curve, which would settle back in line with the guidance. Tapering is essential to regaining the initiative in monetary policy by the Fed.

One must assume that James Bullard has grasped this as he states quite explicitly:

The Committee[FOMC] needs to either:
 Convince markets that the two tools are separate, or
 learn to live with the joint effects of tapering on both the pace
of asset purchases and the perception of future policy rates.”

It cannot simply ignore the taper until it also wishes to change the forward guidance!