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Eight Reasons Why the Fed Will Not “Taper” in September

Wide divergences among economists are felt in polls showing conflicting results concerning the evolution of Feds’ asset purchase program at the next FOMC meeting (Sept. 17-18). The latest poll (Sept. 6) published by Bloomberg suggests that a majority of economists are expecting a slowdown in the Fed buyback program in September:

 

The Fed will start to cut the monthly asset purchases at the Sept. 17-18 meeting, paring them by $10 billion, according to the median of 34 responses in a Bloomberg survey on Sept. 6, after the jobs data. That’s unchanged from an Aug. 9-13 poll.

 
However, the NABE (National Association of Business Economists) survey shows contradictory results to the extent that only 10% of economists expect “tapering” at the coming FOMC meeting:

 

The economists appear to be more cautious in their outlook than Wall Street banks and even some Fed officials that have looked to the central bank’s September 17-18 meeting as a point to begin easing the pace of bond purchases, currently at $85 billion a month.
 
Only 10% of 220 economists polled expect the wind down to start before the end of September. The survey found 39% expect the first tapering of purchases in the final three months of 2013 with the remainder saying the Fed will hold off at least until 2014.

 

Concerning the next FOMC meeting, my conviction remains the same since May 25, I do not expect any announcement about a slowdown in the Fed purchase program. Notwithstanding the fact that the expansionary Fed policy poses risks to financial markets’ stability, especially with the increasing volume of speculative positions (corporate high yield, jumbo loans…), at least eight reasons are legitimizing a wait-and-see policy in the short term:

 

1/ The lack of short-term agreement on fiscal issues, more specifically on the “continuing resolution” and the 2014 budget. Currently, Republicans insist on keeping automatic budget cuts which will take effect during the 2014 fiscal year (starts on October 1st) and will reach $109B (0.6% of real GDP).

 

2/ The threat of automatic budget cuts, which outcome would not be known from the end of September, comes at a time when growth has been low since the beginning of the year. Indeed, even with an upward revision of the 2Q GDP to 2.5% (QoQ annualized), GDP should increase by 3.1% in 3Q and 4Q to meet the projected 2013 growth defined by the Fed in June (ie 2.45% from 2012 4Q to 2013 4Q).
 

 

- Now, if we look at the latest statistics (retail sales, industrial production, durable goods orders…), the trend remains weak and thus far behind the Fed’s target which is partly linked to a slowdown of the buyback program. As a witness, here‘s what Bernanke said at the June press conference:

 

“If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year”

 

3/ The signals from the residential housing market are deteriorating. The recent rise in mortgage rates (highest since April 2011) weighed very negatively on refinancing activity (13 declines recorded in the last 16 weeks) but also on new home sales (-13.4% MoM in July). There is no doubt that existing home sales should fall in August, according to the pending home sales’ decline in July (-1.3% MoM).

 

4/ Inflation is broadly in line (PCE inflation) or below (PCE Core Inflation) the Fed’s forecasts made in June. Anyway it remains well below the 2% target, which is the medium-term reference.

 

5/ Regarding the labor market, it must be recognized that since the set-up of the buyback program (September 2012), pace of nonfarm payrolls has improved whereas unemployment rate has decreased. However, the last report (August) underlines that the short term momentum of NFPs is weakening and is still below the threshold of 200K which is not a minimum acceptable for Fed:
-> Moving average 3 months: 148K
-> Moving average 4 months: 155K
-> Moving average 5 months: 164K
-> Moving average 6 months: 160K
 
- Also, as pointed out by the Fed members during the last Fed Minutes, qualitative indicators, namely the number of long-term unemployed (more than 27 weeks), the number of full-time jobs or the “underemployment rate”, are only improving slightly. Similarly, the decline in the unemployment rate is mainly explained by a fall of participation rate (lowest since Aug 1978) which is not a good thing.
 
6/ The Syrian conflict could create uncertainty to the extent that the debt ceiling has not been raised. The fact is that military action could increase  public spending above expectations and therefore could reduce the time remaining to politicians to find a compromise. Currently, according to Treasury Secretary, the deadline sould be reached by mid-October.
 
7/ During the G20, IMF noted that currently emerging economies are seen as particularly vulnerable to a tightening of US monetary policy and  recommended that policy makers be ready to handle a rise in financial instability. In this context, Fed could choose to give more time to other policy markers.
 
8/ Fed communaction: The Fed members have not yet defined criteria or thresholds which would impact the asset purchase program.
 
- Moreover, since last FOMC, almost all members (voters and non-voters) have instisted on the fact that “tapering” will be only dependent on data which were clearly weaker than expected. The last Beige Book comfirms that activity continued to expand at a modest to moderate pace during the reporting period of early July through late August.
 
- Finally, some people forget that voters are more “dovish” that non-voters and that they give less press interviews.
 
- All Fed members’ speeches concerning QE and economic activity since the last FOMC meeting (July 30-31) are available here.

June Employment Report Shows Improvement regarding Quantity but not Quality

According to the Bureau of Statistics, total nonfarm payrolls increased by 195,000 in June (above expectations), and the unemployment rate remained unchanged at 7.6% against 7.5%e. The average workweek for all employees on private nonfarm payrolls was unchanged in June (34.5 hours) while average hourly earning rose 0.4% MoM:

 

From BLS:

 

Total nonfarm payroll employment increased by 195,000 in June, in line with the average monthly gain of 182,000 over the prior 12 months. In June, job growth occurred in leisure and hospitality, professional and business services, retail trade, health care, and financial activities.
 
The change in total nonfarm payroll employment for April was revised from +149,000 to +199,000, and the change for May was revised from +175,000 to +195,000. With these revisions, employment gains in April and May combined were 70,000 higher than previously reported.
 
The number of unemployed persons, at 11.8 million, and the unemployment rate, at 7.6 percent, were unchanged in June.
 
The average workweek for all employees on private nonfarm payrolls was unchanged in June at 34.5 hours.
 
In June, average hourly earnings for all employees on private nonfarm payrolls rose by 10 cents to $24.01. Over the year, average hourly earnings have risen by 51 cents, or 2.2 percent.
 
In June, the number of long-term unemployed (those jobless for 27 weeks or more) was essentially unchanged at 4.3 million.
 
The number of persons employed part time for economic reasons (sometimes referred to as involuntary part-time workers) increased by 322,000 to 8.2 million in June.

 
I – My view:
 
1/ Nonfarm payroll figures were above expectations such as average hourly earnings (largest MoM rise since July 2011) suggesting that incomes and consumption could accelerate significantly in June.
 
2/ Nevertheless despite higher revision the last two months, the short term momentum is still below the threshold of 200K which is not a minimum acceptable for Fed:
-> Moving average 3 months: 196K
-> Moving average 4 months: 183K
 
3/ The fact is that 200K is only sufficient to absorb new entrants but does not allow to push the number of unemployed lower:
-> The number of unemployed people rose slightly: +17K at 11.777K
 
4/ The other qualitative indicators show very poor performance as:
-> The long-term unemployed (those jobless for 27 weeks or more) was essentially unchanged (-29K) at 4.3 million.
-> Underemployment rate rose from 13.8% to 14.3% because the number of “part time employed for economic reasons” rose 322K.
-> Part-time jobs soared by 360K to 28.059K – an all time record high – while full time jobs were down 240K.
 
II – Implications on Fed:
 
Even if inflation expectations rise because of wage pressures, the employment situation only improved slightly regarding quantity and deteriorated concerning quality. Moreover, another important fact is that participation rate rose the last two months suggesting that a part of people which disappeared from statistics because of cyclical factors (not demographic), is coming back and could support unemployment rate in the coming months.
 
As a consequence, I believe this report does not represent a support for Fed to taper the asset purchases program before December. This view is not shared by Goldman Sachs and JP Morgan:
 

June hiring strength makes it more likely the Federal Reserve will slow its bond buying program in early autumn, rather than at the close of the year, economists at two top Wall Street banks said Friday.
 
Saying the June hiring news was “not too shabby,” JPMorgan economist Michael Feroli told clients in a note that he now expects the central bank to trim what is currently an $85 billion per month bond buying program in September. Before the jobs report, Mr. Feroli had expected the Fed to set in motion the bond buying slowdown in December.
 
Meanwhile, Goldman Sachs also penciled in a September slowdown in Fed bond buying, from December. Noting the June jobs data was better than expected, they liked the payrolls growth, revisions to prior months’ data and the increase in earnings. They downplayed the unchanged unemployment rate amid favorable changes in the number of workers relative to the size of the broader population and overall labor force.

Fed’s Bullard: Reiterates the Fed May Need to Increase QE if Inflation Slows

Federal Reserve Bank of St. Louis President James Bullard dissented from the FOMC’s June 19 decision to maintain the pace of asset purchases saying the central bank may need to increase monthly asset purchases above the current $85 billion pace if inflation slows further below its 2 percent goal.

 

In an unusual move, Bullard published a press release on why he dissented:

 

Federal Reserve Bank of St. Louis President James Bullard dissented with the Federal Open Market Committee decision announced on June 19, 2013. In his view, the Committee should have more strongly signaled its willingness to defend its inflation target of 2 percent in light of recent low inflation readings. Inflation in the U.S. has surprised on the downside during 2013. Measured as the percent change from one year earlier, the personal consumption expenditures (PCE) headline inflation rate is running below 1 percent, and the PCE core inflation rate is close to 1 percent. President Bullard believes that to maintain credibility, the Committee must defend its inflation target when inflation is below target as well as when it is above target.

 

President Bullard also felt that the Committee’s decision to authorize the Chairman to lay out a more elaborate plan for reducing the pace of asset purchases was inappropriately timed. The Committee was, through the Summary of Economic Projections process, marking down its assessment of both real GDP growth and inflation for 2013, and yet simultaneously announcing that less accommodative policy may be in store. President Bullard felt that a more prudent approach would be to wait for more tangible signs that the economy was strengthening and that inflation was on a path to return toward target before making such an announcement.

 

In addition, President Bullard felt that the Committee’s decision to authorize the Chairman to make an announcement of an approximate timeline for reducing the pace of asset purchases to zero was a step away from state-contingent monetary policy. President Bullard feels strongly that state-contingent monetary policy is best central bank practice, with clear support both from academic theory and from central bank experience over the last several decades. Policy actions should be undertaken to meet policy objectives, not calendar objectives.

 

While President Bullard found much to disagree with in this decision, he does feel that the Committee can conduct an appropriate and effective monetary policy going forward, and he looks forward to working with his colleagues to achieve this outcome.

 

After the FOMC, a Bloomberg News survey showed that according to 44 percent of economists, a plurality, the bond buying will be cut by $20 billion at the Sept. 17-18 policy meeting. In my opinion, economists should give more credit to Bullard’s analysis and should not expect any tapering before December. The fact is that inflation will stay very low in the short term because:

 

1/ Global growth will not recover due to China’s slowdown. As a consequence, energy prices will not rebound.

2/ US growth will stay limited around 2% until fiscal issues will be solved (maybe at the end of Q3).

3/ In these conditions, employment conditions will improve slightly and wages’ increase will be contained.

4/ Real estate prices and rents will be affected by an increase in inventory.

FOMC: Downside Risks Have Diminished but Deflation Risk Prevented from Tapering

The FOMC statement shows that the Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall.

 

Nevertheless, partly reflecting transitory influences, the Committee also underlines that inflation has been running below the Committee’s longer-run objective. This is why Fed members revised downward their inflation projection for 2013 from [1.3%-1.7%] in March to [0.8%-1.2%]. Bullard even argued “the Committee should signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings” and voted against  monetary policy action.

 

It also explains why the Committee repeats that it’s prepared to increase or reduce the pace of purchases depending on the outlook for the job market and inflation.

 

More from FOMC statement:

 

Information received since the Federal Open Market Committee met in May suggests that economic activity has been expanding at a moderate pace. Labor market conditions have shown further improvement in recent months, on balance, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy is restraining economic growth. Partly reflecting transitory influences, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable.
 
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic growth will proceed at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall. The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective.
 
To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
 
The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.
 
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.
 
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Jerome H. Powell; Sarah Bloom Raskin; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action was James Bullard, who believed that the Committee should signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings, and Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations.

 
Regarding the press conference, Federal Reserve Chairman Ben S. Bernanke said the central bank may start reducing bond purchases later this year and end them in the middle of 2014 if the economy continues to improve as the central bank forecasts:
 

“If the incoming data are broadly consistent with this forecast, the committee currently anticipates that it would be appropriate to moderate the pace of purchases later this year”
 
“If the subsequent data remain broadly aligned with our current expectations for the economy, we will continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year.”

 
My view

 

The statement and press conference confirmed my view that Fed will not reduce its asset purchases program until at least December and will not end it before Q2 2014. Finally, Fed will stay highly accommodative (low interest rate) for a considerable time after the asset purchase program ends and the economic recovery strengthens.