I fear I need to re-evaluate my conviction that March is the earliest to expect the Fed to begin tapering asset purchases. That conviction was largely based on the belief that the Fed needed to see both stronger and sustainable data to justify tapering. But the bar might be much lower, with only sustainable data necessary. In other words, the Fed may pull the trigger on tapering if incoming data simply suggests the economy is not falling over a cliff. Thus December and certainly January may be more alive than I had believed.
The view of the degree of hawkishness in Fed policy is largely dependent on how one views this line from the October FOMC statement, a line that made its first appearance in September:
Taking into account the extent of federal fiscal retrenchment over the past year, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases.
That line suggests that the Fed largely sees the “stronger” condition to ending tapering as having been met. Yes, I understand where you might think that is crazy. And yes, I realize this implies that the Fed has given up attempting to accelerate economic activity, instead content with accepting the new normal. And yes, I understand that one interpretation of the most recent employment report is that the economy is losing momentum. But note that the Fed does not see the world this way. While they did acknowledge that housing activity slowed since the last meeting, they also noted that overall activity remained moderate. They don’t see a slowdown in broad activity.
Is moderate enough to justify tapering? The answer to that question, I think, is the key to the timing of tapering. The answer also depends upon the degree of FOMC bias against tapering. If the bias is high, as I suspect it might be, then sustained “moderate” is enough.
Also note that an impediment to tapering was removed over the last six weeks, as the Fed changed this line from the September statement:
The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall, but the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market.
to:
The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall.
Neil Irwin, I think, has the correct interpretation here:
The Fed view seems to be this: Conditions were too loose (e.g., bubbly) in April. They were too tight in September. But October appears to feel just right.
Another door to tapering opens if rates remain “just right” in December, or, in other words, financial markets don’t try to front-run the Fed too much between now and then.
Where do I stand on all this? I believe that the Fed has a bias against tapering. Consequently, I think they are looking for an excuse to taper, and looking to force incoming data into the framework of “stronger and sustainable.” But I also anticipate the data to be soft in the next few months as a result of the federal shutdown, soft enough that the Fed will struggle to justify tapering. This is especially the case if inflation continues to track below Fed’s 2% target. Hence I am hesitant to embrace tapering before March. But I also recognize that the risk lies in that direction.
Bottom Line: The FOMC statement is slightly on the hawkish side, opening the door to tapering sooner than March. The argument against tapering sooner is that the Fed needs to see both stronger and sustainable data. But a bias against asset purchases suggests the bar is lower, with just sustainable data needed. Still, this seems to imply that a minimum for tapering is that data do not deteriorate in the near term. The impact of the federal shutdown, however, points to such a deterioration, thus arguing against tapering before March. The degree of the FOMC bias against asset purchases, however, is an unknown in this equation. The stronger the bias, the more likely the FOMC will force the data – even weak data – into the framework of “stronger and sustainable.”
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