The market consensus is that the Federal Reserve will start reducing the size of its bonds-buying program at its rate-setting meeting next week (Sept. 17-18). But the decision on whether or not to taper might be a closer one than many realize.
A Wall Street Journal survey of 47 economists found that 34% thought the Fed would hold off until December. As WSJ editor Phil Izzo noted, that suggests that “at least some market participants will be surprised if the central bank acts next week.”
That’s not surprising. I can see at least three elements of uncertainty hanging over the next Federal Open Markets Committee meeting:
The Fed has been telling us its decisions are data-dependent, but the data has been murky. The main cause of uncertainty is that, since the Fed aired the idea of tapering in May, economic indicators have been neither particularly good nor particularly bad. The latest labour market release was a big disappointment, with only 169,000 jobs created in August, and a hefty downward revision for July, to 104,000 jobs from 162,000. On the other hand, the economy has churned out some good-looking figures on residential construction and manufacturing — and retail sales keep tagging along. Besides, as Izzo notes, if you look at labour market trends, the U.S. has been adding 180,000 news jobs a month since the latest round of tapering started in September 2012, compared to 130,000 in the prior six months.
Another question mark is whether and how much foreign indicators weigh on Fed decisions. Does is matter that the taper talk has contributed to capital flights in countries like India and Brazil? And does it matter that China, who seemed on the verge of recession, has delivered a series of firm economic data in recent weeks?
There’s still some confusion about what “tapering” means. The Fed has noted repeatedly that monetary stimulus is determined by the size of the money supply, not its growth rate. That means tapering is not synonymous with tightening because the central bank would still be adding to the money supply, albeit at a slower pace. Still, that does not seem to have sunk in with a number of investors — and journalists, to be fair — so some market participants might react to a taper announcement as if the Fed was about to start withdrawing stimulus.
A new Fed chairman won’t necessarily keep promises someone else made. When Bernanke’s taper talk caused long-term interest rates to rise much faster than the Fed intended, one of the ways in which the central banks sought to allay market fears was to stress that it would keep short-term rates steady until the jobless rate had reached at least 6.5%. Some analysts are now suggesting the Fed might strengthen that forward guidance by lowering the unemployment threshold to 6%. That might well happen, but the Fed that’s making promises now won’t be the same Fed in charge of keeping them a few months from now.
The Fed’s Board of Governors could have up to four vacancies by January, which is, of course, also when the new chairman steps in. While Janet Yellen would be pretty much guaranteed to stick to the current plan on short-term rates, Lawrence Summers would make for a much more inscrutable and possible unpredictable Fed chief. Whether or not markets believe the Fed’s pledge on interest rates might affect the magnitude of their reaction to a taper announcement.
Erica Alini is a reporter based in Cambridge, Mass., and a regular contributor to CanadianBusiness.com, where she covers the U.S. economy.