Crescenzi: Fed Sees Escape Velocity as Tentative

As Fed Chairman Ben Bernanke indicated recently on 60 Minutes, today's FOMC statementindicates that the Federal Reserve feels that the U.S. economy has only tentatively achieved escape velocity, such that the Fed must continue to provide fuel to push the rocket ship further into orbit.

This is obvious in the fact that the Fed improved only slightly upon its assessment of the U.S. economy, as well as by the Fed's characterization of growth as "insufficient to bring down the unemployment rate." So little was changed in the policy statement that it gives the impression the Fed feels amply justified in maintaining its asset-purchase program. This was likely an intention of the statement.

Looking ahead, the Fed suggested that its asset purchase program will remain scaled to economic and financial conditions, as evidenced in the following statement, which was identical to the one delivered on November 3rd:

"The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability."

Ben Bernanke, Federal Reserve Chairman
Ben Bernanke, Federal Reserve Chairman

The minimal change the Fed made to its assessment of the economy is in keeping with the Fed's modus operandi, which is to subordinate the newest economic data to cumulative data. Sometimes it takes a couple of quarters before the Fed is convinced of a change in economic conditions sufficient enough to substantially alter the language in a policy statement, let alone policy itself. Recent data have been strong enough to make this possible; so we again must remember that policy will be scaled to economic and financial conditions, and they are improving. Upcoming policy statements are likely to reflect the recent improvement in economic conditions.

Those that say the asset-purchase program is a failure are too narrowly focused on the yield on the 10-year Treasury note. For starters, we can't know how high the 10-year's yield would otherwise be if not for the Federal Reserve's bond purchases. A better way to view the efficacy of the Fed's asset-purchase program is to consider its impact on financial conditions more broadly; for example, by considering the so-called rebalancing effects resulting from investors moving out the risk spectrum. A substantial effect of the asset-purchase program is that it has led investors to believe that short-term rates will be kept low for an extended extended period. This compels investors to take risk, buoying risk assets.

Keep in mind that there is normally at least 6 months spacing between one monetary-policy regime and the next, which therefore means that if the Fed continues its asset-purchase program through June, any rate hike possibility is a ways off. This will help anchor yields, just as the low inflation rate will, preventing a breakout in rates and keeping the 10-year yield largely within the 3 to 4 percent range it has been in for most of the past three years.

Tony Crescenzi is Senior VP, Strategist, Portfolio Manager Pimco. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the author of "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market."