The Most Likely Taper Timing

by: Russ Koesterich, CFA

Economic news was generally positive last week, with the highlight being a strong November payrolls report. In response, many investors are wondering if the positive data means that the Federal Reserve (Fed) will soon begin tapering its asset-purchase programs.

What's my take? As I write in my new weekly commentary, while a December taper is certainly still possible - I'd put the odds of it at around 30% - I see an early 2014 as the more likely timing. Here are three reasons why:

1. While November's non-farm payroll numbers were better than expected, they were not so good as to cement a December tapering. November's jobs data marked the second straight month in which more than 200,000 jobs were created, and the unemployment rate significantly dropped to 7.0%. However, while job creation has modestly accelerated from last year's levels, it's still not so strong as to necessitate an early end to quantitative easing (QE).

2. Wage growth remains weak. Though job creation is accelerating, it's not accelerating fast enough to push wages up. Hourly earnings are only growing by 2% on a year-over-year basis, while another report showed that U.S. personal income fell by 0.1% in October. Anemic wage growth is a long-term structural problem, since without faster rising wages, consumer spending is unlikely to improve.

3. Inflation remains subdued. The Fed has significant latitude to take its time. Most measures of inflation are closer to 1% rather than the Fed's long-term target of 2%. If anything, over the next year, deflation is probably a greater threat than inflation.

The bottom line: Thanks to a slowly improving labor market, anemic wage growth and a still reluctant consumer, economic growth is likely to remain modest and inflation low. As such, while it's still possible that the Fed will announce tapering of its bond purchases this month, early 2014 seems the more likely timeframe.

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