It seems that crowd is increasingly inclined to expect that the Federal Reserve will begin to slow its bond-buying program next week, at the conclusion of its FOMC policy meeting on Wednesday, Dec. 18. Yesterday's sharp drop in the U.S. stock market is one sign that the Mr. Market is preparing for a change in the monetary weather in a few days. But is this fate? One reason for remaining a skeptic: inflation, which still looks quite low relative to the Fed's target.
Tim Duy offers a round-up of recent analysis that leaves room for doubt that next week will formally mark the beginning of the end for quantitative easing. He concludes:
The Federal Reserve wants to taper. Wants very badly to taper, in my opinion. The recent employment reports seem to be giving a green light, and I suspect they are coming around to the idea that the decline in the labor force participation rate is largely permanent at this point, which will only increase their angst about the asset purchase program. But inflation is a thorn in their sides. The Fed will need to do a 180-degree turn on its current inflation concerns. If they dismiss the inflation concern in their drive to taper, I suspect they will lean on the stable inflation expectations and Phillips Curves arguments to justify a forecast that has inflation quickly reversing course and trending to target. I still tend to believe the Fed will delay tapering until 2014. Whether December or January or later, policy is close to an inflection point with a shift from more to less accommodation in the works.
Meanwhile, The Wall Street Journal notes that the Fed's "preferred inflation measure has been undershooting the central bank's official 2% target in recent months, hovering at about half that level. A new paper from the San Francisco Fed suggests the trend is likely to continue despite policy makers' hopes that the decline would be temporary."
Indeed, the trend of late for the Fed's preferred inflation measure--the core (i.e., less food and energy) change in personal consumption expenditures--is running at a 1.1% year-over-year rate through October. The disinflationary momentum is quite strong these days, and so at the moment it seems that the prospects appear nil that inflation will hit the Fed's 2% goal in the immediate future.
In short, the burning question is whether the upbeat economic news of late trumps the weak inflation numbers? I, for one, would be surprised if the Fed makes a clear and unambiguous statement that announces that the tapering has started… NOW! I'm expecting more finesse, perhaps along the lines of promises to act sometime next year, if the economic data cooperates.
But the weak inflation numbers still suggest plenty of uncertainty about the timing. Having moved heaven and earth in monetary terms in recent years, is the Fed willing to err on the side of a premature taper vs. letting inflation run a bit hotter for longer? Hmmm. Given the weak inflation trend, it seems there's a decent chance that the taper talk may be MIA next week after all.