Morgan Stanley interest rate strategist Matthew Hornbach is tired of the incessant chattering about “the taper” (the moment when the Fed starts to reduce the pace of monthly asset purchases).
Whether it happens in December, January, or March is not that big of a deal anymore. Everyone knows it’s coming and the ultimate impact of the timing at this point isn’t a big deal.
So what should you be talking about: Everything else the Fed does while it tapers. What other language tools will it use in conjunction with a slowing rate of asset purchases?
His note is several pages long, but here’s the key conclusion (which we explain in more detail below):
Investors should stop talking about tapering and start talking about potential changes to the rate guidance framework. In our view, the exact timing of tapering should be a secondary concern. What matters is whether the Fed combines tapering with a reduction in the Unemployment Rate Threshold or an introduction in a new inflation floor. The thresholds are all about credibility, so the Fed must understand how each option will impact the market’s perception of its commitments to remain on hold. Our economist’s base case is that the Fed pairs a modest tapering with a 50bp cut in the URT. In our view, the risk to that base case is a more aggressive 100bp cut paired with a larger taper.
Remember, right now the Fed says it won’t consider a rate hike until unemployment falls to 6.5%. The hot new idea, which has been propagated by Goldman and others, is that the Fed will reduce this level to 6.0% at the same time it introduces the taper, so that it can provide some verbal easing even as the pace of asset purchases slows down.
And then there’s this idea of an inflation floor, which Matthew Boesler wrote about last week. The idea is that the Fed could give more oomph to forward guidance by promising no rate hike as long as inflation was below a certain level. So this is what you should be talking about, not the Dectaper, Jantaper, Marchtaper parlor game.
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