The Federal Reserve shocked the world in September when it
refrained from taperingits open-ended large-scale asset purchase program (LSAP). Also known as quantitative easing, LSAP consists of monthly purchases of $US85 billion worth of bonds in an effort to stimulate the economy.
In the wake of the announcement, economists quickly began pushing back their initial tapering expectations to December. And then those expectations got pushed back to March 2014, which is when current Vice Chair Janet Yellen is expected to be at the helm of the Fed.
But in another twist, Morgan Stanley’s Matthew Hornbach throws out the possibility that the Fed might wait until June 2014 to taper. From Hornbach’s latest note (emphasis added):
The Case for the First Taper in June 2014
What could keep the Treasury market supported beyond the end of 2013? Or what could send Treasury yields even lower than our expected range over the near-term — i.e., below 2.20-2.40%? In our view, the market would have to shift the largest probability of tapering past the March 2014 FOMC meeting.
What could cause that to happen? If the market comes to believe that the Fed needs to see acceleration in real GDP growth in order to feel comfortable tapering, the market will focus on the timing of when that growth acceleration is likely to show up in the data. If the market believes that the acceleration in real GDP growth is unlikely to show up in 4Q13 (Morgan Stanley economists believe 4Q13 real GDP growth is tracking below 2.0% annualized, currently), then 1Q14 is the first quarter where growth could accelerate above the recent 2% annualized trend.
If the Fed waits until the Bureau of Economic Analysis (BEA) reports real GDP growth for 1Q14 (end of April 2014 for advance release), it could possibly taper at the April 29-30 FOMC meeting. If it wants to wait for the first revision of 1Q14 GDP (end of May 2014) because of the downward revisions to 1Q13 that occurred this year, the Fed might not taper until the June 17-18 FOMC.
Additionally, most GDP forecasts by economists currently assume that the law that triggers an automatic sequester in 2014 as a part of the Budget Control Act of 2011 will not be implemented to full effect in 2014. However, if the Congress is unable to agree on a delay to the sequester, it could lead to more fiscal drag in early 2014 than currently expected. Such a fiscal drag would be a headwind to the acceleration in growth that the Fed might be seeking. This may lead the Fed to delay tapering until much further beyond the first or second quarters of 2014 to better assess the negative consequences of the fiscal drag. While this is not the base cases of our economists, it is a plausible scenario the market may consider pricing in. This would take 10-year Treasury yields further below our 2.20-2.40% target range into year-end.
As seen by the recent government shutdown, Congress has proven to America that it can’t be counted on even when the economy is on the line. As such, the odds of a June 2014 taper is certainly above zero.
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