Investors worldwide have been playing a jittery guessing game. When will the U.S. Federal Reserve trim back its massive bond-buying program that has helped fuel stocks’ recent record highs? And once it has done that, when might the central bank start raising interest rates again?
The answer — or an answer, at least — can be found in this simple graph, albeit at the risk of putting too much emphasis on the labor market and insufficient emphasis on the broader economy. That still lacks anything more than modest momentum, while inflation — an important caveat to the Fed’s quantitative easing (QE) exit — isn’t yet near the Fed’s target.
But the Fed itself has cast this game in terms of “stronger and sustainable” employment. The central bank’s policymakers have indicated that unemployment falling to 7% is the trigger for the end of its current QE and that 6.5% is the unemployment-rate threshold that has to be passed before consideration can be given to raising rates. The chart above shows the monthly U.S. unemployment rate from its peak of 10% in October 2009 to July’s 7.4% (the blue line). The black line is the trend rate, projected forward to the spring of 2015. The red line is the QE trigger and the green line is the rate threshold.
The points of intersection suggest QE will be done by late spring of 2014 and rates won’t rise before late fall. Chairman Ben Bernanke has gone out of his way to make it clear that the central bank considers the two to be separate events in terms of monetary policymaking. He has signaled a prolonged period of low rates. The 6.5% number is a threshold, not a trigger.
As for when the Fed will start to taper its bond purchases so they can be wound down by next spring, there may be a clue hidden in the graph above. Unemployment has been falling recently more closely in line with its trend than it was earlier in the year. That may be sufficient to reinforce the Fed’s belief in its baseline economic forecast despite the softness some economic indicators have been showing across the summer. In which case, tapering would likely start sooner rather than later — even as soon as September.