Taper Tamper Timing: Speculation Still The Top Market Mover
Speculation about when the taper starts remains by far the top market mover. So did the dramatic events of last week change the likely timing and pace of QE's eventual demise?
Short version: Probably not. Despite last week's bullish surprises Thursday and Friday, the likely start date remains no earlier than March 2014, with an outside chance of an earlier small, symbolic taper, and an even better chance of a later start.
Here are the details on why we believe the taper isn't coming soon.
- Liquidity Trap: Taper Risks Spiking Rates
Markets remain fixated on the start and pace of the coming (?) fed stimulus tapering. Normally bullish news of growth brings selloffs because it raises the risks of an earlier, faster reduction in QE, which is believed to be the one thing that truly justifies current and possibly higher risk asset prices.
As we discussed at some length here, the Fed faces what Nomura's Richard Koo called a liquidity trap - any material taper risks spiking rates and killing the very recovery which justifies the taper.
Thus the strong US GDP beat Thursday, which implied greater odds of an earlier taper, was enough to tank not only US markets, but even European indexes, despite their having the very bullish benefit of a surprise ECB rate cut. That's usually grounds for a rally, as it frees up more cash to flow in equities and also weakens the EUR and so makes EU exports more competitive.
True, the bullish US jobs report the next day didn't generate a similar taper-phobic selloff, but we hold the "good news is bad news" mechanism is still engaged. The Friday bounce was likely due to:
- The smart money didn't believe the jobs report was reliable
- Stocks had hit significant technical support at the bottom of its near term trading range anyway, and the rally that followed was nothing more than a bounce back to the top of the same recent trading range, as shown in the S&P 500 daily chart below.
S&P 500 DAILY CHART 16 SEPTEMBER - 8 NOVEMBER 2013
Source: MetaQuotes Software Corp, www.fxempire.com, www.thesensibleguidetoforex.com
On Thursday (second candle from the right) the selloff was only to near term support around 1747. This was strong multi-layer support comprised of:
- Recent resistance-turned support that has held firm through repeated tests since October 25th
- The 10 (dark blue) and 20 (yellow) day exponential moving averages (EMAs)
Then on Friday the rally was just a bounce within the narrow recent trading range back up to near term resistance that has held firm through repeated tests since October 28th.
In sum, volatility yes, net progress in either direction since October 5th, no.
So markets were ready to bounce, and that made everyone happy going into the weekend:
- Traders got a nice short term bounce for a tradable rally
- The media got enough drama to keep audience figures and ad revenues healthy
- Main street got some optimistic news that might help save the holiday shopping season after ominously soft back-to-school and Halloween season sales.
Therefore, while many analysts are saying that the Friday rally shows that markets are returning to their normal behavior of rallying on strong data (see here, here, and here for examples), we don't have the evidence for that. Friday's rally was likely a just a narrow trading-range bound technical bounce that only retraced Thursday's drop, and the jobs report was simply a good excuse. Note how, in the above chart, despite two consecutive days of top-tier reports that both smashed expectations, Friday's rally didn't even challenge the recent highs.
Here are other reasons why the Fed is not likely to taper tamper (except perhaps for a symbolic start just to ease the transition for a nervous market) before March 2014 at earliest. In sum, they boil down to the risks outweighing the benefits.
- Inflation Remains Low, So No Urgent Pressure To Taper
Inflation (for personal consumption expenditures that was out Friday morning and which the Fed relies on more than it does on CPI for an inflation read) remains low, so there is little risk of hitting the Evans rule 2.5% CPI limit that would push the Fed to taper out of inflation fears.
- Fed In Transition
It makes much more sense to leave the timing and pace of a taper to the new Fed Chairperson, Janet Yellin, who won't be settled in until March 2014. If the taper starts before then and we get a string of weak data, it will be harder for her to suspend or reverse the stimulus cutback. If she did, she'd risk:
- Looking indecisive
- Looking like she doesn't really have a clear plan or picture of where the economy is going (that's true, but it's a myth the Fed is loath to remind us of, given that it helps calm markets)
- Causing avoidable volatility in markets (as the fed did between May and September) and again bringing criticism on the Fed of sending contradictory messages and failing to communicate its intentions.
- Recent Good GDP, Jobs Data Suspect
As mentioned above, the strong GDP and jobs reports are encouraging, but there are real questions as to whether they accurately reflect real growth. Some of the doubts include:
- Regarding the GDP report: Questions about whether or not the build in inventory, which was what accounted for the good report, was due to slack demand causing inventory to accumulate, or to businesses restocking in anticipation of coming sales. For a detailed look at these, see our report on the meaning of the GDP beat: The Big US GDP Beat: Hype Versus Reality.
- Distortions in data from the government shutdown: See here for details on why, in the words of Felix Salmon, the jobs report was case of "garbage in garbage out," dubious data generating a dubious report.
The fed is aware of these issues and thus unlikely to pay much attention to either the GDP or jobs report, despite the headlines and volatility they generated.
- Taper Risks Counteracting ECB Surprise Rate Cut
The surprise rate cut signaled the ECB is worried about the EU economy, or at least of appearing to not be doing enough about it. Given the international nature of credit markets, any US tightening would to some extent be a damper on EU growth as well (though it would send the EUR lower vs. the USD, which would help EU exports). Thus a Fed taper risks countering the ECB's attempts at easing, and also strengthens the EUR and so makes EU exports less competitive.
Another EU crisis hurts everyone, so the Fed will certainly consider how a US stimulus cut affects the EU recovery.
- Risks To Economy From Possible Next Budget Battle
After the government shutdown and debt-ceiling standoff, you might have thought that Congress would become less confrontational in order to avoid another embarrassing performance in the coming months. In fact the atmosphere remains confrontational and there is an excellent chance for a repeat performance. If that happens, the economic damage may be worse, and the Fed must consider that risk.
In sum, the Fed has a variety of good reasons to oppose an early taper, and no immediate pressure or strong reason to favor it.
No "Real" Early Taper Likely
Ok, maybe, maybe a symbolic one in hopes of easing markets into the idea and avoiding rate shock, particularly if:
- data remains supportive, which is far from clear given the question marks hanging over the otherwise solid GDP and jobs figures
- the initial taper is small enough to be seen as symbolic and thus allow incoming Fed Head Yellin the option of holding off on any material cuts if growth data stalls without appearing to reverse course. Remember, the fed is improvising based on the data, but it likes to maintain the appearance of having some grand master plan based on some (non-existent) proven financial models. It makes people feel better and thus calms markets somewhat
For further conclusions see our post on "Lessons For The Coming Week And How To Profit" here.