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After “Government Shutdown”, the Fed Will Not “Taper” Until at least December

This morning, the U.S. government began a partial shutdown for the first time in 17 years which will put as many as 800,000 federal employees out of work. Moreover, according to IHS, partial shutdown would cost U.S. at least $300 million/day in lost economic output (0.002% of real GDP) at the start.


More from Bloomberg:


A partial shutdown of the federal government would cost the U.S. at least $300 million a day in lost economic output at the start, according to IHS Inc.
While that is a small fraction of the country’s $15.7 trillion economy, the daily impact of a shutdown is likely to accelerate if it continues as it depresses confidence and spending by businesses and consumers.


The impact on the economy will be minimal if the shutdown is short, however, the risk is that the debate could drag on until October 17th (Treasury deadline).


In this context, the Fed will maintain a very accommodative policy letting its asset purchase program unchanged at least until December meeting (December 17-18). Indeed, it is very unlikely that Fed will start “tapering” at the October meeting (October 29-30) for several reasons:
1/ Inflation remains particularly low and well below Fed’s target:
* PCE Core inflation and PCE inflation were revised downward in Q2 from 0.8% (QoQ Annualized) to 0.6%.
* PCE Deflator YoY WAS 1.2% in August and was revised downward in July from 1.4% to 1.2%.
* Prices for gasoline on the New York Mercantile Exchange have fallen roughly 11% in September.
2/ Growth will remain sluggish:
* Fiscal issues were already weighing on companies’ expectations as the BRT (Business RoundTable) third quarter CEO Economic Outlook Survey fell to its lowest level since Q4 2012.
* The latest figures suggest that Q3 GDP, which will be published on October 30, will be slightly below 2% (QoQ Annualized).


3/ Jobs report and other economic reports will be delayed or cancelled according to Reuters. Without figures which sow a significant improvement concerning labor market, the Fed will not “taper”.

The United States will stop publishing much of its economic data next week if the government shuts down, including the closely watched monthly employment report, officials said on Friday.


4/ Given the recent trend in inflation, growth and the fact that employment report will be delayed or cancelled, Fed members’ speeches (voters) since last FOMC suggest that “Octaper” is unlikely:
* On September 18 – Fed Chairman Bernanke (dove, FOMC voter) / There is no fixed calendar for tapering, it could begin this year, depending on data. – FOMC press conf
- Fed to maintain highly accommodative policy.
* On September 20 – Fed’s Bullard (moderate, FOMC voter) / GDP is tracking below 2%, thought it would be higher at this point – speech in New York + comments
- Removing accommodation when inflation is below target is concerning. Fed must hit inflation targets.
- Want to see a recovery in inflation before adjusting stimulus program, inflation is expected to rise over the upcoming quarters.
* On September 23 – Fed’s Dudley (dove, FOMC voter) / Reiterates that Fed policy will continue to be driven by incoming economic data – speech in New York City
- Fiscal uncertainty is one issue impacting the schedule for exiting QE, along with market interest rates and less good data.
* On September 26 – Fed’s Stein (dove, FOMC voter) / US still requires accommodative policy – speech in Frankfurt
* On September 27 – Fed’s Evans (dove, FOMC voter) / Needed to defend inflation from below as well as above – comments from Oslo
- Tapering could start in Oct, Dec, but could be pushed to Jan.


All Fed members’ speeches concerning QE and economic activity since the last FOMC meeting (September 17-18) are available here.

Eight Reasons Why the Fed Will Not “Taper” in September (An Update)

Just before the FOMC statement on September 18, I think it’s interesting to make an update of my post concerning arguments against “tapering”.


Indeed, 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 still 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).


-> Senate Majority Leader Harry Reid said last Thursday that deep divisions within the House Republican caucus are imperiling passage of a fiscal year 2014 stop-gap spending bill and threaten both a government shutdown and a default. Note that this bill would keep the government funded until Dec 15 and should include sequestration of $109 billion.


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).


-> The last statistics (August retail sales, Wholesale inventories…) suggest that actual growth (3Q) is below 2%.


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).


-> Mortgage applications decreased 13.5 percent from one week earlier, according to data from the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey for the week ending September 6, 2013 (14 declines recorded in the last 17 weeks). The Refinance Index decreased 20 percent from the previous week and has fallen 71 percent from its recent peak (the week of May 3).


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.


-> A diplomatic breakthrough Saturday on securing and destroying Syria’s chemical weapons stockpile averted the threat of U.S. military action for the moment. It means that Syrian conflict is not a longer an argument against tapering.


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.


To replace my argurment on Syrian conflict, I choose to focus on future changes at the head of the Fed.


8bis/ Changes at the head of the Fed in 2014. The next year, the voting members will be more “hawkish” with the arrival of Fisher (Dallas Fed President) and Plosser (Philadelphia Fed President). Therefore, knowing that committee in place in 2014 would quickly end the asset purchases program, the actual committee could delay “tapering” to compensate.

Eurozone Recovery Could Take Place in Q3 2013

According to the PMIs’ surveys published this morning, Eurozone business activity resumed modest growth in July for the first time since the start of 2012.


More from Reuters:


Euro zone private industry unexpectedly bounced back to growth this month as factories increased output for the first time in well over a year, business surveys suggested on Wednesday.
Markit’s flash Eurozone Composite PMI, based on surveys of thousands of companies across the region and a reliable indicator of growth, jumped to an 18-month high of 50.4 in July from 48.7 in June.
That smashed even the most optimistic forecast in a Reuters poll and is the first month the PMI has been above the 50 mark that divides growth and contraction since January 2012.
“It’s a very encouraging picture, it’s pretty broad-based. Germany is leading the pack followed by France but even the periphery … is seeing a return to growth in manufacturing,” said Chris Williamson, chief economist at data collator Markit.
Williamson said the latest PMI results tentatively pointed to 0.1 percent gross domestic product growth in the 17-nation bloc in the current quarter, in line with a Reuters poll taken earlier this month.


These figures were unveiled while the main central banks of the euro area (Bundesbank, Bank of France and Bank of Spain) upgraded their forecasts concerning Q2 2013. Indeed, on July 22, Bundesbank reported that German economy grew at a stronger pace in Q2 (after 0.1% in Q1) with more moderate growth seen in Q3:


The assessment that the German economy expanded strongly in the second quarter after a weather-related weak start to 2013 is being confirmed by current indicators. Important contributions to growth in the second quarter should come from industry and construction.

On July 23, Bank of Spain estimated that the Spanish economy likely contracted 0.1% in the second quarter from the first.


Spain’s central bank said Tuesday the euro zone’s fourth-largest economy likely contracted 0.1% in the second quarter from the first, the latest sign that Spain may be close to emerging from a recession started in late 2011.

In the first official estimate of quarterly economic performance, the Bank of Spain said gross domestic product likely contracted 1.8% from the second quarter of 2012. In the first quarter this year, the economy had contracted 0.5% on the quarter and 2% on the year.


Finally, on July 8, Bank of France upgraded its forecast for Q2 GDP to 0.2%:


France’s economy is expected to have grown 0.2% in the second quarter, the Bank of France said Monday, as it revised upward its prediction from last month.
In its previous estimate, the French central bank expected French gross domestic product to grow 0.1% from the previous quarter.


As a consequence, by taking into account the weight of each economy in the euro area (Germany: 27%; France: 21% and Spain: 12%), we could simulate Eurozone GDP with more precision:


Growth Forecasts
Scenario Pessimistic Central Optimistic
Germany 0.3% 0.4% 0.5%
France 0.1% 0.2% 0.3%
Spain -0.2% -0.1% 0.0%
Others -0.2% -0.1% 0.0%




Growth Contributions
Scenario Pessimistic Central Optimistic
Germany 0.081% 0.108% 0.135%
France 0.021% 0.042% 0.063%
Spain -0.024% -0.012% 0.000%
Others -0.080% -0.040% 0.000%
Total -0.002% 0.098% 0.198%
Total (rounded) 0.0% 0.1% 0.2%

In the central scenario, based on the main central banks’ expectations and on the assumption of a less deeper recession in other countries, Eurozone growth could now reach 0.1% in Q2 2013. Therefore, if the momentum stays positive in August and September, Eurozone could technically exit recession in Q3 2013 (two positive quarters), which will be faster than expected.

China Removed the Lower Limit on Lending Rate

On July 19th, China announced interest rate reform and removed the floor in lending rate. The change, effective on July 20th, abolished a floor set at 30 percent below the current 6 percent benchmark, giving banks freedom to set their own lending rates. The statement also unveiled other measures:
=> To scrap ceiling on lending rates for rural credit cooperatives.
=> To remove curbs on Bills discount rate.
=> To continue differentiated lending policies for housing sector:
- To keep lending floor for individual home loans.
- To keep lending floor for mortgages unchanged.
*** Still need to curb speculation in housing market
=> To keep deposit rate floating rate unchanged.
*** Liberalizing bank deposit rates needs mature market conditions.
*** Note: Previously, China set a minimum limit on interest rates and maximum limit on deposit rates in order to support the lending margins of state banks.

My view


- By a step-by-step process, China is liberalizing the money market. These measures will help to increase competition between banks.

- Lending rates should decrease helping growth to accelerate in H2. It will lower financial costs for companies and households, yet,  banks’ margin (spread between lending and deposit rates), which represents almost 80% of net results of the four largest banks, will be under pressure.

- Chinese authorities stay coherent to the extent that they still try to curb speculation in housing market.