On Friday, the August Non-Farm Payrolls report came out and it was weak. Not only did it miss headline expectations, but there were significant downward revisions to past months.
And yet despite that, there’s still a general belief that the Fed will “taper” (reduce the pace of Large-Scale Asset Purchases) starting at its September meeting.
Trader and economist Mark Dow has a great explanation of the Fed’s thinking.
Basically, the Fed is realising that QE isn’t having the positive goal on real-world economic data that its biggest supporters would like, and that it’s impact is mostly psychological. It doesn’t believe that tapering is tightening (since the balance sheet will still be expanding) and so the best move then is to end QE in a controlled and predictable manner, so as to learn on other tools (like the zero interest rate policy).
QE has triggered significant effects in markets and indeed helped buy precious time for household balance sheets to heal and animal spirits to revive. This has been an important contribution. But it is now clearer that the primary channel through which this has taken place is psychological. Most everyone now knows that the money “pumped in” by QE has largely remained as reserves on the balance sheet of the Fed. The money that “flowed” into asset markets here and abroad came from us, not the Fed, as our risk appetites increased.
It was virtually impossible for the Fed to have gauged ex-ante the magnitude of our psychological response to its easing. But because the market response has been so large yet the economy is still far from where the Fed would have hoped to see it by this point in time, the weaning of market psychology off of the Fed teat now has to be handled in a balanced and incremental fashion. Signaling will play a central role in this process.
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