While most economists have increased the probability of a December taper announcement,
most nevertheless continue to believe it is unlikely.
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.
Deutsche Bank’s Joe LaVorgna is part of the tiny minority that expects the Fed to announce tapering at the conclusion of its FOMC meeting on Wednesday.
He considers what happened in September when the Fed shocked markets and unexpectedly refrained from announcing tapering earlier in the fall.
Importantly, at the time of the September FOMC meeting — when policymakers ultimately got “cold feet” — there were four main factors weighing on their decision-making: a potential stumble in the housing data, a loss of momentum in the pace of hiring, anticipation of a potentially disruptive government shutdown/debt ceiling standoff and a perceived failure of market participants to draw the distinction between tapering and the timing of future rate increases. Since September, there has been significant improvement with respect to each of these factors.
LaVorgna expects the Fed to announce a $US10 billion reduction in Treasury purchases while keeping mortgage bond purchases going at full speed.
Importantly, LaVorgna expects the Fed to reassure the markets that tapering is not tightening. In other words, it’ll articulate that despite tapering, it’ll do what it can to keep interest rates very low for a very long time.
“In order to more firmly anchor interest rate expectations when the tapering commences, the Fed will strengthen its forward guidance on the funds rate, likely by lowering its unemployment threshold to 6.0%,” wrote LaVorgna.
At the conclusion of the Fed’s FOMC meeting on Wednesday, it will also update its economic forecasts.
“At present, the Fed’s central tendency forecast for the unemployment rate in 2015 is 5.9% to 6.2% and 5.4% to 5.9% for 2016,” noted LaVorgna. “The tone of the Committee’s economic assessment should be considerably upgraded relative to October.”
We’ll cover the FOMC announcement live on BusinessInsider.com.