Fed Tapering Turns Out to be a Head Fake


After much talk in the markets that the Fed was definitely going to taper its Quantitative Easing program by the end of September, it turns out that nothing is happening after all. Are you really surprised? You are if you believe the prevailing thought instead of looking into the drivers of the decision.

The Fed has said repeatedly that it would reduce Quantitative Easing if the economy substantially improves. (1)(2) While the numbers are suggesting that there is some improvement in employment, housing and consumption, it is not really that much. The employment numbers are expected to be significantly improved when the unemployment rate falls below 6.5%. It is currently only at 7.3% and it is quite persistent at the level of 7%.

When the tapering announcement was first made months ago, was there any thought given to the market reaction of the action itself? If less money is being printed, this means there is less money in the economy. The supply of money would go down, bringing the cost of money up, which is equal to higher interest rates. The bond and mortgage markets have signaled this already. (3) What happens when interest rates rise? Consumption goes down, housing sales go down and unemployment numbers go up. Are these not the same indicators used to justify the cancellation of the tapering in the first place? Even if tapering were to happen, the economy would not keep up its momentum, and the Quantitative Easing program would likely have to expand once again.

Adding to this backdrop is the possibility of a government shutdown due to political wrangling over the debt ceiling. (4) This likely will not do much in the short term, but it is a signal that the debt is still rising, and the problem is not going away. There is also the passage of “Obamacare”, which is a large unknown in that it is not clear how expensive this program will be, and what the reaction of market participants will be. (5) This will exaggerate the sluggishness in the economy because of the uncertainty of the situation. One final variable is the hiring of a new Fed Chairperson, which could possibly throw a wrench into the works either by delay of a policy until the new person gets settled, or a change in policy which will cause disruption to the status quo.

What to take from this? Tapering is not coming any time soon, and if it does, it is not likely to last.

Sources:

1)      http://blogs.reuters.com/macroscope/2013/05/30/snapshot-where-fed-officials-stand-on-ending-qe3/

2)      http://www.nytimes.com/2013/09/19/business/economy/fed-in-surprise-move-postpones-retreat-from-stimulus-campaign.html?pagewanted=2&_r=0

3)      http://www.bloomberg.com/news/2013-09-17/less-tapering-becomes-tightening-credit-no-matter-what-fed-says.html

4)      http://www.reuters.com/article/2013/09/17/us-usa-debt-idUSBRE98G0KD20130917

5)      http://www.businessinsider.com/obamacare-will-change-how-you-work-and-retire-2013-9

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About joetheinvestor
Joe Barbieri has Bachelors degrees in both Civil Engineering and Commerce from the University of Toronto. He has worked in the Financial Services field for over 12 years, covering positions from Retail Customer Service and Fund Accounting, through to Investment Research on the Institutional side. He has worked in 5 companies, spanning banks, a mutual fund, a Consulting Firm and a Large Canadian Pension Plan. He currently has a Chartered Financial Analyst designation (CFA) from the CFA Institute. He has recently published articles in Pension and Benefits Monitor Magazine as well as the Internet.

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