Monday, September 16, 2013

To taper or not to taper, that is the question.

It’s all eyes on the Fed this week as it contemplates whether to announce the timeline for tapering its asset purchase program.  As I’ve said consistently over the last few weeks the data that’s important to that decision is decidedly mixed.

Recent data has included some positives such as the more forward-looking PMI surveys, but some of the actual activity data such as durable goods, factory orders and consumer spending has been on the soft side.  In fact my Q3 GDP forecast of 2.2% (seasonally adjusted annual rate) is lower than June’s 2.5%.  That said I still think that by the time we get December data, the second half of the year will have proven to be stronger than the first half, but not by much.

The labour market has been a more consistent performer but at a slower rate of improvement now than appeared just a few months ago.  It wasn’t that long ago that payroll gains were averaging 200k per month in 2013.  That average has now slipped to just over 180k.  That’s not bad, but neither is it great.  The August unemployment rate dipped lower again to 7.3%, but again on the back of a decline in the participation rate, which in itself is hardly a sign of a robust labour market.

Furthermore, inflation remains low and stable, with not much in the way of indication that current low inflation will prove transitory.  In fact the quarter-on-quarter annualised rate of increase in the core personal consumption expenditure deflator continues to move down.

From my perspective then the labour market data is a “yes” for tapering, inflation is a “no”, and growth is a “maybe”.  However, since the Fed Chairman Bernanke first openly contemplated tapering markets began to price it in.  Pragmatism (i.e. reducing uncertainty and volatility) suggests to me the FOMC will announce its tapering plan this week, but as I’ve said before, the mixed nature of the data suggests a gradual approach to reducing its purchases in the order of $10 billion per month from the current level of $85 per month.

I also expect that given they are transitioning back to forward guidance as the primary policy instrument, we will see the Committee wanting to reinforce its zero interest rate policy by dropping the level of the unemployment rate at which it will start to contemplate interest rate increase.  That is currently 6.5% and appears likely to be lowered to 6.0%.  The mechanics of recent declines in the unemployment rate justifies such a move.

I was also going to comment this morning on the debate about the next Fed Chair, but with Larry Summers having pulled out of the race there isn’t much point.  It suits the promotion of my own views however to make one point and it’s this: I think Summers has been unfairly labelled as anti-QE and therefore hawkish.

My read of his comments is that he is not so much anti-QE as he is questioning of its effectiveness.  I have considerable sympathy with that view.  But be consistent.  If he thinks it has been ineffective at stimulating demand then he is unlikely to think that it would be a problem for inflation.  I don’t buy the argument that he would have unwound QE faster than a Bernanke or a Yellen and that he would ultimately be proven to be more hawkish.  The think the biggest risk for monetary policy is a policy mistake, and given the Fed is in uncharted waters, the risk of making a mistake seems the same regardless of who is in the Chair.

Furthermore, I continue to be bemused by the weight of expectation that is placed on the role of monetary policy to fix what ails America.  A necessarily broader policy response is still required.  I think that’s two points so I better stop now.