As expected, our buddies over at the Federal Reserve decided to keep monetary policy in check. What came off as somewhat of a surprise though, was how Bernanke and his band of merry men were very tight lipped, refusing to give the markets even the slightest hint as to when they plan to taper off asset purchases.
Instead, the Fed merely downgraded its outlook on the economy (from “moderate” to “modest” pace) and expressed concern about the labor market.
Naturally, this caused traders to wonder if the Fed will actually begin reducing bond purchases next month, which has long been the rumored start date for the central bank’s taper process. Here are some reasons why Fed officials may be having second thoughts:
1. Inflation Remains Subdued
Part of the statement included a quip about how inflation remains below the central bank’s target of 2% and how this could pose a threat to Uncle Sam’s economic performance.
Considering how the PCE index – the Fed’s preferred inflation measure – is still clocking in at around 1.0%, this could mean that the Fed believes that there’s still a ton of room for them to keep rates low and to maintain the current level of monthly bond purchases.
2. Rising Mortgage Rates
The recent Fed statement also revealed that policymakers are starting to feel uneasy about the rise in borrowing costs, particularly in the housing market. Although the housing sector has shown some improvements this year, rising mortgage rates could undermine demand later on.
In fact, a couple of recent reports have shown that higher rates have started to take their toll on sales. Pending home sales slipped by 0.4% in June while existing home sales failed to meet expectations of a 5.27 million reading and came in at only 5.08 million.
So far though, data from the Mortgage Bankers Association of the U.S. showed that interest rates on 30-year fixed rate mortgages have eased in the past weeks after hitting their two-year high in July.
3. Weak Growth Prospects
The U.S. advanced GDP report for the second quarter of this year printed 1.7% growth, higher than the estimate at 1.1% but still relatively sluggish. Aside from that, the Q1 2013 GDP figure was revised down from 2.5% to 1.8%.
One of the main factors weighing on overall economic performance is the ongoing sequester of the U.S. government. Analysts fear that the effects of the budget cuts could continue to drag growth lower in the coming months and may lead to even bleaker GDP figures for the rest of the year.
On a more positive note, components of the GDP report revealed that consumers continued to spend despite the increase in taxes while business investment ticked slightly higher. Unless these sectors are able to keep compensating for the other weaknesses in the U.S. economy, the Fed might have to think twice about pushing through with its stimulus taper next month.