Conventional wisdom as to the likely outcome of this week’s Fed meetings seems to be shifting. Only a few weeks ago, it was hard to find anybody who diverged from the commonly held view that March 2014 was the most likely date for the infamous “tapering” to begin. Now it seems that you can’t turn on a TV or open a newspaper without hearing somebody opining that a reduction in the pace of bond purchases is likely this week.
Two things have changed to precipitate this. Most importantly, there is more evidence that the economy is improving. Last month’s jobs numbers were better than expected, and it is beginning to look as if the jobless recovery is not so jobless anymore. There is still a problem with hardcore, long term unemployment, but that is more of an issue for our beloved political leaders than for the Fed. Talking of politicians, while the budget agreement reached last week was small in scope and still has to garner enough votes to get through the Senate, it at least indicated a chance that Washington will not be torpedoing the recovery this time around.
There has also, it seems, been a shift in the language used by FOMC members in recent public pronouncements. Many have indicated that they are aware of improving employment conditions and are prepared to consider reducing the $85 Billion per month of bond purchases that the Federal Reserve currently makes. With all of these clues around, it is no surprise that news outlets are now breathlessly reporting polls that show around one third of economists surveyed expect tapering to begin this month.
This is a classic example of “framing” news, however, and should be taken as a warning by anyone who gets swept up in this kind of thing. If these results were being reported as “Two thirds of economists do not think tapering will begin this month” our perception of the same polls would change.
So, why would they not begin to extricate themselves from what was only ever intended to be a temporary policy? Well, while improvement in the jobs market has most frequently been cited as a condition to be met for tapering to start, it isn’t the only one. Inflation is running at around 0.7%, well short of the Board’s stated target of 2%. GDP growth around 2.5% isn’t bad considering the government shutdown earlier this year, but it hardly speaks of rampant growth and a rapid recovery, and there is evidence that many people are still feeling the pinch.
This chart from the Federal Reserve Bank of St Louis, reproduced here, shows that after surging as the recovery began, both average weekly earnings and personal consumption have shown little or no improvement for several years.
For what it’s worth, I am inclined to believe that the committee will wait to see what the holiday season brings in terms of consumer strength before making a decision. I am beginning to think, however, that whatever they decide, the effect on the market will be limited and short term.
The last couple of weeks have seen some weakness in equities as the belief that tapering could start immediately has taken hold, but to some extent this may mean that such an eventuality is priced in. I mean, if the Fed does decide to go to $75 Billion a month in purchases rather than $85 Billion, the initial reaction is likely to be downward, but is that really going to precipitate a mass exit from stocks? Similarly, any decision not to taper will undoubtedly be followed by a great big “yet.” They will leave the door open for a reduction in January, or whenever they see fit and we all know it coming, so any relief rally is likely to be temporary.
The actions of the Federal Reserve Bank, and QE in particular, have been such important drivers of market moves in the last couple of years that we have come to see them as the only thing that counts. QE has been important for sure, but the continued ultra low interest rate policy that the Fed has maintained and which they still are committed to is, in many ways more influential now that there are signs of a real recovery.
I don’t believe, then, that this week’s meetings and subsequent announcement will be an important driver of real market moves, no matter what the hype. Whatever the decision, QE will still be around for the foreseeable future and short term interest rates will remain around zero; the policy will remain “accommodative.”
There will probably be a knee-jerk reaction to any announcement, but I will be looking to trade that reaction in a contrary manner rather than following momentum. This is particularly true if this week unfolds as I expect and Chairman Bernanke’s last press conference is used to announce no change for now. The prospect of continued QE may produce a rally, but there are other reasons I believe a correction is due before too long.
You could be forgiven for thinking, as the hype around the prospects for a reduction in QE builds this week that we are awaiting a momentous decision, but we aren’t; what will be announced will be simply a matter of the timing of a minor change to a long established policy. This change will undoubtedly have some effect, but it may turn out to be less important than you think.