FOMC Preview December 2013
Fundamentals Update as at 9 December 2013 by Lorenzo Beriozza
With improved labor market data as a backdrop, market participants have pulled forward their expectations of an initial Fed taper. Given the equanimity with which the bond and equity markets absorbed the strong November employment report on Friday morning, it is looking increasingly likely that the Fed initial taper will come in December or January.
Arguments for a December taper
- Bernanke said in June, “If the incoming data are broadly consistent with [our] forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year.” A December taper would be consistent with that guidance.
- Tapering would at least get started at the 7% unemployment rate at which QE3 was earlier envisioned to end.
- Concern about frothiness in several financial markets.
- Fed is buying larger percentages of assets as gross MBS production slows and near term Treasury budget deficits shrink.
- Market participants may be starting to understand that tapering does not imply a change in the Fed’s overall accommodative policy stance.
- There is a post-meeting press conference already scheduled for December 18.
Arguments against a December taper
- A taper announcement at the FOMC meeting on December 18 would leave only two business days before a two-week stretch of thin market participation around Christmas and New Year’s Day.
- The labor market is weaker than the headline figures suggest (i.e., the “Yellen indicators,” while improving, are still mixed at best).
- FOMC members may not be convinced that the recent headline labor market improvements will be sustained.
- Inflation is still running well below the Fed’s 2% target, and the outlook is for more of the same through at least 2014.
- Both Bernanke and Yellen have said they currently don’t see risks to financial stability, despite some evidence of a collective reach for yield.
- A press conference can easily be scheduled for January 29, if necessary.
Size and composition
The initial taper is likely to be modest in size and balanced in composition. The FOMC most likely will cut back its current monthly $40bn MBS /$45bn Treasury purchases by $5bn each to $35bn MBS/$40bn Treasuries, for a new monthly total LSAP of $75bn. Another option would be an initial taper of $15bn, a $5bn cutback in MBS purchases and a $10bn cutback in Treasuries.
This would bring the monthly asset buying to $35bn each of MBS and Treasuries – the merit of this being mainly that it brings the two sizes into alignment. Even those Fed policymakers who argued for a tapering back in mid-September were not advocating a dramatic approach. Rather they suggested that the FOMC move gingerly: “Most of the participants leaning toward a downward adjustment in the pace of asset purchases also indicated that they favored a relatively small reduction to signal the Committee’s intention to proceed cautiously.”
The composition of a potential taper was discussed in some detail in the minutes of the October 29-30 meeting. On this issue there appeared to be no consensus: “A number of participants believed that making roughly equal adjustments to purchases of Treasury securities and MBS would be appropriate and relatively straightforward to communicate to the public. However, some others indicated that they could back trimming the pace of Treasury purchases more rapidly than those of MBS, perhaps to signal an intention to support mortgage markets, and one participant thought that trimming MBS first would reduce the potential for distortions in credit allocation.”
Markets seem fixated on the timing and details of the initial Fed taper. But that move would represent only the first of a centipede’s worth of shoes to drop in the months and quarters that follow.
It would not come as a surprise if at its December meeting, the Fed announces a decision to hold press briefings after each of the FOMC’s eight meetings per year. If this is correct, then Bernanke’s final press conference would be on January 29, two days before his term as Chairman expires on January 31.
Source: Credit Suisse
