DEUTSCHE BANK: 'Twas The Night Before Taper...'

In a new research note to clients today, Deustche Bank economist Joe LaVorgna reiterates his expectation that the Federal Reserve will announce the tapering of quantitative easing at the conclusion of its Federal Open Market Committee (FOMC) meeting on Wednesday.

Tapering refers to the gradual reduction of the Federal Reserve’s monthly purchases of $US45 billion worth of Treasury securities and $US40 billion worth of mortgage bonds. The program has been intended to stimulate the economy by keeping interest rates low and credit market liquidity high.

From LaVorgna’s note titled “‘Twas The Night Before Taper…”

We are looking for a $US10 billion Treasuries only taper — we have been projecting this since the much stronger-than-expected October employment data (reported on November 8), which was subsequently matched by a similarly strong November employment report. Current quarter growth prospects continue to brighten with second half output poised to average over 3%. Moreover, the budget sequester was loosened, as we also had anticipated, so there is little reason for the Fed to delay tapering, in our view. The fact that the 10-year Treasury yield is at nearly the same level as it was right before the September FOMC, while the timing of the initial rate hike was pushed out at least six months from early 2015 to late 2015, tells us that the financial markets are indeed expecting a taper. There is now much less concern on behalf of monetary policymakers that a taper will engender a further tightening in financial market conditions. Indeed, since the September non-taper, equity prices are higher and credit spreads are tighter…

“The Fed will blunt any negative reaction to a taper by strengthening the forward guidance through a lower unemployment rate threshold,” he said.

Most economists will acknowledge the points LaVorgna makes. Still, the consensus is that we won’t here about tapering until January or March.

One of the most common arguments against tapering has been inflation, which has been surprisingly low. Many also note that the numbers behind the falling unemployment rate are still quite week.

We’ll find out tomorrow.

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