Why The Fed Has To Taper This Week If It’s Going To Taper At All

Ben Bernanke
Federal Reserve Board Chairman Ben Bernanke takes his seat to testify before a Senate Banking, Housing and Urban Affairs Committee hearing on ‘The Semiannual Monetary Policy Report to the Congress’ on Capitol Hill in Washington July 18, 2013. REUTERS/Kevin Lamarque

Tomorrow, Wall Street expects the Federal Reserve to announce the first reduction in the pace of monthly bond purchases it makes under the quantitative easing program (QE3) it introduced in September 2012.

Right now, the Fed is buying $US85 billion in Treasuries and mortgage-backed securities each month.

The consensus on the Street is that the Fed’s FOMC monetary policymaking apparatus will elect to reduce that amount by $US10 billion going forward.

The FOMC says its decision to taper is contingent upon improvements in the health of the labour market, yet the data have been disappointing in recent months. The U.S. economy added only 169,000 workers to nonfarm payrolls in August, below consensus estimates for 180,000. July payroll growth was revised down to 104,000 from 162,000.

So, what’s the rush to “taper” QE3?

The Fed may be feeling opportunistic.

“We maintain our longstanding view that, while no time is perfect, the best opportunity this year for the Fed to initiate a cutback in its asset purchases will be at the upcoming September 17-18 FOMC meeting,” says Credit Suisse chief economist Neal Soss in a recent note to clients.

Here’s why, according to Soss:

We would venture that the majority on the FOMC has a preference to commence the so called “taper” of the Committee’s large scale asset purchases (LSAPs) in September. The reason is the calendar. If FOMC policymakers don’t begin tapering this month, the next opportunities are their October 29-30 and December 17-18 FOMC meetings.

October is likely to be right in the middle of the debt ceiling fight. In general, people think these fights will end without tearing the fabric apart, but then again, nearly everyone expects a heightened degree of contention and disharmony. Also, President Obama may announce a nominee for Bernanke’s successor in mid-to-late October. This would not be an ideal moment for the central bank to experiment with a potentially disruptive operational change.

The next opportunity after that is the December FOMC meeting. With only minor exceptions, Ben Bernanke has been on a one-way easing street for over six years, beginning back in the summer of 2007. Does he really want his last holiday present to the nation and world economies to be a potentially negative shock?

So, they probably have a predisposition to start now.

Others on Wall Street agree.

Drew Matus argues in a note that September and December are really the only two viable choices, because there is no press conference following the October meeting. Bernanke, he says, will likely want to be able to explain such a momentous policy shift with a press conference.

Matus then offers three reasons why September is more likely than December:

  1. Even with the recent mixed data, polls (from The Wall Street Journal and Bloomberg) suggest that a modest taper is widely anticipated by market participants. This would reduce the odds of an unwanted dramatic market response to the announcement.
  2. The chairman’s influence has already begun to wane (the last time we heard from the Bernanke was July 18) and will only wane further upon the announcement of his replacement, an event likely to occur before the December 18th FOMC decision. As such, it would be better for him to address questions regarding the taper while not a “lame duck” chairman.
  3. In the event of a negative equity market reaction, it would seem to be better to have the impact in September, post the back-to-school shopping season, rather than in the thick of the Christmas shopping season, when a negative market reaction could derail consumer spending.

“When they sit down at the massive mahogany table in that marble building on Constitution Avenue,” says Morgan Stanley chief U.S. economist Vincent Reinhart of the FOMC, “they will tell themselves that forward — looking indicators suggest ongoing momentum to activity, financial conditions remain accommodative, and markets are receptive to risktaking.
If not now, when?

BofA Merrill Lynch economists, on the other hand, maintain that the Fed will wait until December to announce the first reduction in QE3. Read their argument here »