All markets want for Christmas is a taper delay
It's been nigh on eight months that the debate on tapering has been raging in financial markets and we still remain no closer to any clarity on when we can expect a slowdown in the pace of the Feds asset purchase program, though the stars do appear to be aligning for the possibility of a taper today, though it still remains an outlier.
Some in the market thought we would see the beginning of just such a paring back in September, and in fact St. Louis Fed President James Bullard indicated just after that meeting that a taper was a close call at the time, even though it didn't happen.
Some criticised the Fed at the time for its communications policy after it maintained the pace of the program at its current levels, but when looking at the data it was never the done deal a lot of market participants had thought it was, particularly in light of the impending deadlock in US politics and the government shutdown later in the month. The jobs data wasn't as strong, though subsequent revisions have since seen it revised higher.
Quite simply the markets misread the Fed's intentions and as with anything investors who get burned have a tendency to lash out.
Given the length of the government shutdown the consensus view had been that March 2014 was the most likely date now for the Fed to look at tapering, but this line of thinking has changed in recent weeks given the resilience of recent economic data in spite of the government shutdown.
If a Fed taper was always about the data then the strength of the recent numbers out of the US does shift the debate towards a nominal taper, a view that was given added credence last week when one of the doves on the FOMC, James Bullard articulated just such an opinion.
Today's decision really comes down to the numbers and whether or not Bullard decides to shift position and how many FOMC members he can bring with him. There is also the possibility he could have been flying a trial balloon with his comments, or did he really mean what he said?
The consensus view appears to be that a taper is not priced in, but I would disagree and that the Fed now has an opportunity to act in a way that would test the temperature of the market, like dipping its toe in a hot bath.
Since May US bond yields have jumped from 1.8% to 2.8%, which suggests that some form of taper must be priced in which would suggest that the Fed could get away with a nominal taper of $5bn to $10bn without causing too much market mayhem.
Some in the markets have expressed the view that the Fed could demur because inflation remains below target, which is true, but if economic growth continues then that is unlikely to be a problem.
The time of year has also been cited as an obstacle due to low market liquidity, and that is a concern, but if the Fed doesn't act now when the data appears to be heading in the right direction, and there has been a budget agreement, then it begs the question, what is holding them back and whether it really is about the data?
Now is the time to be bold and grasp the nettle, the debate has been going on for far too long, we're fed up with writing about it, do it now and water down the punch bowl, the sun will still rise tomorrow, and the Fed will still be pumping up to $75bn to $80bn a month into the US economy.
Given the Feds track record the more likely outcome would be to maintain the status quo and it would appear that markets are banking on this but wouldn't it be refreshing if the Fed acted of its own accord and not at the whim of the markets. It did it in September; it should do it again now.
If the Fed does hold, then look for indications from Bernanke's press conference for any hint of the timing of taper beginning in January, particularly if the Fed upgrades its economic projections.
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