Economy

How Congress could derail a September taper: Erica Alini

The Fed might play it safe and wait

CB_time-to-clear

(Armando Arorizo/Pi/ZUMA Press/Corbis)

The financial markets seem to believe that tapering will start next month. Anticipating higher returns in the U.S., investors have been falling over each other to ditch Indian assets and showed remarkably less appetite for Canadian bonds, too — all as if the Fed was to announce that it will start scaling back its bond-buying program at its next rate-setting meeting on Sept. 17-18. There’s one big reason why that might not happen: Congress.

In the July Federal Open Market Committee minutes (pdf), released yesterday, the Fed appeared to highlight four major snags that could convince it to stay put beyond September: signs that rising interest rates are hurting the housing recovery; weakness in the labour market; trouble in the global economy; and more fiscal austerity. After yesterday’s stellar home re-sales report — the best in nearly four years — it’s probably safe to cross out number one. Number two could take the form of a disappointing August jobs report, due out on Sept. 6. So far, though, nothing indicates that the next labour market numbers will be significantly better or worse than the past few months. Number three could be much more of a problem, in part because of seismic adjustments worldwide due precisely to the anticipated end of QE. I’ve mentioned India’s struggle with capital flight, an issue facing other emerging economies such Indonesia and Brazil. But there’s also China, where a housing and financial bubble could pop and turn the current economic slowdown into a hard landing. Still, the good news on that front is Europe: The eurozone has formally crawled out of recession, the U.K. is coming along at modest but positive pace, and Eastern Europe is being buoyed by growth in Germany. The fourth spoiler, more shenanigans in Washington, seems the most likely to materialize.

Congress failed to pass a budget before summer recess, with the House using a total spending amount of $967 billion and the Senate sticking with $1.058 trillion. If they fail to come to agreement by Oct. 1, the start of the 2014 fiscal year, the federal government might shut down. The solution would be for Congress to pass a “continuing resolution” that would fund the government at last year’s level. But that would mean another round of mild fiscal austerity that would weigh on growth. Crucially it would also mean an estimated $4.2 billion in federal funding cuts to the states, where public-sector employment is just now recovering. Seen how Congress tends to push things to the 11th hour, it’s unlikely that Democrats and Republicans will have solved the impasse before the FOMC gathers in mid-September.

There also another way in which Congress might derail a September taper timeline. If you listen to the latest buzz, House Republicans are now thinking of triggering a crisis over the debt-ceiling debate, likely coming up in late October, rather than the federal budget.  The July FOMC minutes didn’t mention the risk of another debt-limit standoff, but it’s reasonable to assume the Fed might decide to hold off tapering if the markets start getting anxious about new crazy talk from Washington.

In short, the next fOMC meeting will be too soon to tell just what heights the new drama in Congress will reach. The Fed might decide to play it safe and wait.