When the Federal Reserve concludes its two-day Federal Open Market Committee (FOMC) meeting at 2:00 p.m. ET today, it’ll reveal whether or not it has decided to begin tapering.
Tapering refers to the gradual reduction of the Fed’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.
According various surveys of the market economists, it appears that the expectation is for no taper announcement today. Rather economists expect the tapering announcement to come in January or March.
But a closer reading of the economists’ commentary shows that there is very low conviction in any forecast related to the tapering.
Low Conviction Language
“No one should be shocked if tapering is announced, but we expect it to be delayed for at least one more meeting,” wrote High Frequency Economics Jim O’Sullivan on Monday who’s on the record for calling for a January tapering announcement.
But O’Sullivan’s sentence is loaded. The phrase “No one should be shocked” implies a relatively high probability of a tapering announcement today.
“We put the probability of them tapering tomorrow somewhere between 50-50 and 60-40,” said PIMCO’s Mohamed El-Erian to Bloomberg TV on Tuesday.
“60-40” is a fantastic way of saying it might and it might not. You can’t be wrong with that range. Former Fed Vice Chair Donald Kohn used that same language in a discussion with his Potomac Research Group clients.
O’Sullivan, El-Erian, and Kohn aren’t alone in using this ambiguous language. Here are some highlights from the FOMC previews we’ve read (Emphasis added. Translation offered.)
Goldman Sachs’ Jan Hatzius: “Fed officials face a more difficult decision at their meeting next week, as the employment and growth data have picked up since the October meeting. But our central forecast for the first tapering move remains March, with January possible as well. We see a decision to taper next week as unlikely for three reasons.”
TRANSLATION: March, maybe January.
UBS’s Maury Harris: “We believe still-low inflation is likely to preclude a taper at the December meeting as a still-cautious Fed awaits more evidence that recent gains in the labour market and consumption can be sustained while avoiding any action that could derail the holiday shopping season. We continue to expect the first taper to be announced at the Jan. 29 FOMC meeting. We look for a modest initial taper of $US10 billion, concentrated in Treasuries. However, we concede the odds of a December taper have risen and would put the chance of a taper next week at 33%.”
TRANSLATION: January, but don’t rule out December.
Bank of America Merrill Lynch: “…In our view, this meeting will be defined by what the Fed doesn’t do: we see a low chance of the start to tapering or meaningful changes to forward guidance. Rather, we look to Chairman Bernanke’s final press conference for a broad discussion of Fed policy options into next year. He is likely to signal both that tapering could start early next year — conditional on the data — and that the Fed will be patient and gradual as it winds down its purchase program. We also expect him to indicate that the Fed will strengthen its forward guidance if needed, but keep his options open. The overall tone should be modestly dovish, especially relative to market expectations of potential start to tapering. We expect him to reiterate that the Fed intends to keep policy accommodative well into the future in order to support a broader and more sustained recovery.”
TRANSLATION: January or March, and they might say something about it in December.
Credit Suisse’s Neal Soss: “There are several other arguments to consider for and against a Fed tapering as soon as this month. Our assumption remains that the next monetary policy move will be toward fewer asset purchases balanced by strengthened forward guidance on retaining low policy interest rates. And the likely timing of such a decision now appears to be practically a toss-up between December and January.”
TRANSLATION: December or January.
Morgan Stanley’s Vincent Reinhart: “…If the outcome of the December FOMC meeting falls in line with our expectation, we would most likely take the low probability we placed on tapering at the December meeting and shift it into January. We will make this determination following the conclusion of the press conference, taking into consideration the context of all that the statement, accompanying materials, and press conference holds.”
TRANSLATION: It depends on a bunch of other things.
To be fair, there are some economists who offer tapering calls with much higher conviction.
Here’s Why This Is Happening
We can think of at least three explanations for why the language is so vague and wishy-washy.
- There’s no precedent. Post-financial crisis monetary policy has always been unprecedented, so there’s really no model that economists can use to predict what happens next.
- They got it wrong last time. All but one of the economists we follow predicted that the Fed would announce tapering back in September. And as we now know, all but one got it right. Stocks exploded higher after the announcement, and economists surely got yelled at by clients.
- It’s about more than just tapering. Morgan Stanley’s Vincent Reinhart offers perhaps the least definitive language about taper-timing. But maybe that’s the point. Monetary policy has a lot of moving parts. In other words, it’s a bout more than tapering and it should be considered only in the context of what else the Fed might say.
It Doesn’t Matter What The Fed Says About Taper
Remember Matthew Hornbach? He’s the Morgan Stanley interest rate strategist who destroyed one of the key arguments supporting the September taper calls.
In his December 10 research note titled “Stop Talking About Tapering,” he explains why we should just.. stop talking about tapering.
Investors should stop talking about tapering and start focusing on what comes with the first taper. Most bond market investors are comfortable with the idea of tapering at one of the next three FOMC meetings. It should not matter much which meeting. What matters more is whether the Fed combines tapering with a cut in the unemployment rate threshold (URT) or a new inflation floor.
In other words, today’s announcement is about much more than whether or not the Fed announces a taper. What matters is everything else the Fed says.
With that in mind, here’s Morgan Stanley’s expectation via Hornbach:
While our US economists expect the Fed to begin tapering at the March 2014 FOMC meeting — the headline most market participants care about — they also believe the Fed will lower the URT to 6.0% from 6.5%. In many ways, addressing the URT first makes sense, given the proximity of the actual unemployment rate to the current 6.5% threshold. Moreover, potential changes to government unemployment benefits could drive unexpected shifts in the unemployment and participation rates. Our economists suggest there is a great deal of uncertainty surrounding how the expiration of the benefits will affect the behaviour of participants in the long-term unemployed program (currently 1.33 million).
The announcement comes at 2:00 p.m. ET. We’ll cover it live on BusinessInsider.com.
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