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R.I.P. Forward Guidance Thresholds - Long Live Good, Old-Fashion Communication

07/02/2014 12:07 GMT | Updated 08/04/2014 10:59 BST

When it comes to the Fed and the Bank of England, I think it's going be 'déjà vu all over again'.

Let's take the Fed first. When is a threshold not a threshold? Answer - when it doesn't suit one's agenda.

With the unemployment rate plummeting towards the 6.5% 'threshold' hitherto touted for the Fed to consider rate increases, we were told in the statement released following their December meeting that the FOMC, 'now anticipates that the funds rate will be held unchanged until "well past" the time that the unemployment rate has fallen below its 6.5% threshold'. This was a meeting at which a majority in favour of just lowering the pesky threshold to 6.0%, or even 5.5%, obviously couldn't be found. Thank goodness; this is certainly a testament to the sagacity of the Committee, as moving the goal posts so soon after they were inserted into the ground would have been seriously detrimental to the Fed's credibility - what's to say the threshold wouldn't suddenly become 5%, or even be abandoned completely when it was subsequently convenient?

We should bear in mind that in many ways this was the outgoing, dovish Fed's final act, with Helicopter Ben at the helm, (or the cyclic, I guess); the FOMC composition became distinctly more hawkish at the January meeting.

Regional voting Presidents James Bullard, (centre/dovish), Charles Evans, (dove), Eric Rosengren, (dove), and Esther George, (hawk), rotated off, to be replaced by Richard Fisher, (hawk), Sandra Pianalto, (centre/hawkish), Charles Plosser, (hawk), and Narayana Kocherlakota, (dove).

Fisher and Plosser both dissented against the introduction of calendar-based forward guidance in August 2011 and the start of Operation Twist in September 2011. Moreover Stanley Fischer, the new, uber-impressive Vice-Chair, (I wonder if Janet Yellen watches House of Cards!), could probably be described as centre/hawkish, in stark contrast to Bernanke, whom he effectively replaced.

No surprise then that the January meeting saw another $10bn reduction in QE and no lowering of thresholds.

So what of the next meeting in March? My guess would be that by then several clouds that have been obscuring the health of the US economy, and hammering risk assets, will have blown over. I don't feel that by any means all emerging markets will have escaped the cosh, but I do feel that we will have avoided widespread contagion, a la the 1997/8 Asian/Russian Crises, and that the pressure will be seen as contained and upon the most vulnerable - Argentina, Brazil, Turkey, South Africa, say, whereas key Asian nations will be relatively calm - India, China, Indonesia, Korea and Taiwan.

I do feel that headline US unemployment will be lower by then and that there will be a burgeoning realisation that we shouldn't devalue that because of low participation rates - widespread academic research has highlighted that a large proportion of the fall in participation rates has been caused by demographics - to somewhat over-simplify; baby boomer retirees - and is not going to race back up cyclically. Finally, US economic data will hopefully just be free of both government shutdown and weather distortions, and looking very healthy.

Against this backdrop, I would certainly expect a further $10bn tapering, but also some further downgrade in emphasis on the unemployment threshold, with added weight being given to growth in hourly earnings and maybe also a wider set of indicators, including consumer spending, durable goods orders, industrial production, the Fed's Beige Book, etc, i.e. pretty much a death knell for threshold-driven forward guidance and a return to old-style messaging, based upon the Fed's perception of macro-economic developments.

Here in the UK, the BOE faces a very similar dilemma and next week's release of the Bank's Quarterly Inflation Report, (QIR), will surely be significant with regard to the tweaks to forward guidance that the Bank must surely now feel are unavoidable. As in the US, unemployment is crashing, and this week's January UK Services PMI Reading, although only a tad lower at 58.3, from 58.8 in Dec, boasted sub-components that still made excellent reading, with the key employment index moving higher, along with the outstanding business index which, at 55.3, stands at its high since 1997. At this rate Q1 growth is looking like 1.0% qoq.

I do not expect the QIR to announce a reduction in the unemployment threshold to 6.5%, say, but I do expect to see a nod to other metrics, such as wage and productivity growth. There must also be a 25% chance that they take a leaf out of the Fed's book and introduce a version of the Summary of Economic Projections, with a record of individual MPC members' views on the future path of the Bank's Base Rate - basically RIP forward guidance, long live old-style insight into the MPC's thinking and reaction function.

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