The Fed convenes for the last time in 2013 and the option to taper bond buys is certainly on the table. Will the Fed follow through with its road map from June and announce the beginning of the of Quantitative Easing?
Here are no less than 11 reasons for Ben Bernanke and his colleagues to push through with a big change in policy:
- Solid job growth: The recent non-farm payrolls report showed a gain of 203K jobs. The 200K level is sometimes considered as the threshold between stall speed and good growth. This report isn't a one off, but rather in line with figures in the past year: an average of 195K jobs was gained in the US in the past 12 months, significantly higher than the average of 150K seen when QE3 was launched back in September 2012. Also the Fed's favorite jobs figure, JOLTS, continued rising.
- Fall in the unemployment rate with a natural fall in the participation rate: The unemployment rate dropped to 7%, partially enjoying a drop of the participation rate to 63%. Nevertheless, a Fed study shows that the drop in the participation rate seen in the last year and a half is totally due to retirement. So, the better than expected drop in the unemployment rate is not due to discouragement to search for a job, something that has been seen beforehand.
- June plan: Bernanke mentioned that QE tapering could begin when the unemployment rate drops to 7%, and that it could happen later in the year, with QE fully ending in mid 2014. The Fed never said that the plan has changed.
- QE tapering does not imply a rate hike: After a long time, it seems that the markets have gotten the message coming from the Fed: tapering and ending QE altogether doesn't mean that the next immediate step is raising the short-term interest rate (Federal Funds Rate). Rate hike expectations have been pushed back. This separation of expectations also enables Bernanke and Co. to lift the leg from the pedal without causing a full stop.
- Market preparedness: When Bernanke opened the door to QE tapering in May and June, a storm hit the financial system. Stocks fell and emerging markets saw a quick outflow. As time passed by and after the no-taper decision in September, markets are much more ready for the change. One of the reasons for not tapering in September was "tighter financial conditions." This has certainly improved and the Fed even removed the mention of tighter financial conditions in its October decision.
- Healthy core inflation: One of the arguments against QE tapering was the fear of deflation. This fear triggered QE2. And while inflation is moderate, it still remains healthy, at least in the core figure that the Fed eyes. The fresh report for November, showing a steady 1.7% rate, is unlikely to stop the taper train.
- Strong rise in house prices: The S&P/Case Shiller House Price Index showed a gain of over 1% in house prices in the 20 biggest US cities in September. Year over year, this is a gain of 13.3%. Double digit gains in house prices are not new. These rises were partly fueled by low long-term interest rates which the Fed addressed via the Quantitative Easing program. The Fed has been blamed for blowing the housing bubble of the mid 2000s and wouldn't like to be seen as fueling another bubble.
- Less political headwinds: After the government shutdown and debt ceiling scare seen in October, the decision not to taper bond buys in September certainly made sense in hindsight. Not only has the US economy shrugged off the government shutdown, but another one isn't around the corner after politicians reached a deal.
- Fed hints: Various FOMC members spoke out toward this decision. The hawks remained hawks and the doves remained doves, but where did those in the middle lean to? They certainly said that QE tapering is on the table. The most interesting speaker is James Bullard. The president of the Federal Reserve Bank of St. Louis voted against the Fed's road map for QE tapering in June, and now said it is a valid option. He is not alone.
- Bernanke's legacy: Bernanke introduced the unconventional policy of QE during the financial crisis. The first round was certainly efficient in containing the crisis, the second one prevented deflation and the third one supported the recovery in employment. The effect of the programs is controversial, but the fact that the effect is diminishing from program to program is something that the Fed printed in its official statements. Before Bernanke steps down, he might like to push for the beginning of the end of QE.
- Timing: the next Fed decision will be released on January 29th, and Bernanke steps down on the 31st. It is unlikely that such a major turn in policy will be made when Bernanke has one foot in the door. The first meeting chaired by Janet Yellen is only in March. Four months is a long time, even for central bankers.
There are far less arguments against QE tapering.
- Debt ceiling: While a government shutdown in January has been averted, the debt ceiling is still hanging above the US economy and it might be reached somewhere between February and March. This could deter the Fed from making a move. Yet the deal on the budget certainly provides hope for a resolution also on this issue.
- Santa rally: The Fed historically prefers the first and second quarter for beginning tightening cycles. Stock markets tend to rally in December, in what is commonly known as the "Santa rally." So, Bernankemight refrain from making the move just now.
All in all, there are high chances of QE tapering in December, the "Dectaper." What do you think?
Stay tuned for scenarios and market reaction for the big event.