By Walter Kurtz, Sober Look
The Fed’s new approach to targeting a specific unemployment rate (called the “Evans’ Rule”) may shed some light on how long the monetary easing may continue. Credit Suisse did a simple linear extrapolation from the peak unemployment rate in 09. Such approach sets the end of the program for late 2014.
That of course assumes the unemployment rate will continue declining in a linear fashion (which may be unrealistic given the structural shift in employment). It also assumes that labor participation (something the Fed is tracking closely, though it’s not part of the official target) will improve with falling unemployment – another “leap of faith”.
This extrapolation gets to the “target” considerably faster than the FOMC’s “middle of 2015” projection or even the Fed Funds futures curve market expectation (Feb-2015 contract now implies full 25bp).
The new unemployment targeting program (combined with inflation tolerance level) is expected to make for a more flexible policy tool because the FOMC would be less reluctant in adjusting its rate expectations. CS researchers think both the FOMC and the futures markets will adjust to an earlier date as the unemployment rate continues to decline (some comments in brackets [ ] ).
CS: – The Fed’s date guidance by no means “nailed down” the markets expectations but certainly made them stickier as innovations to the Fed’s rate guidance would not be costless. On the margin the Fed would have traded some credibility for flexibility at some future date when an inward shift in the date became necessary. [English: with the old approach, changing the expected date of the end to zero rates would have been harder, though not impossible.]
In the final analysis we think the market will realize the Fed can and will move the thresholds if unemployment continues to fall rapidly on the back of lower unemployment. But that will take time to sink in. In the meantime we think the blue eurodollars  are free to trade.
Still, a linear trendline fitted to the unemployment rate since the peak in 2009 would suggest reaching 6.5% in late 2014. A continuation of the more recent pace of declines would imply and even earlier date.
Fed Funds futures implied rate
Latest posts by Sober Look (see all)
Did you have a comment or question about this post, finance, economics or your love life? Feel free to use the discussion forum here to continue the discussion.*
*We take no responsibility for bad relationship advice.