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Fed Watchers: Beware the Taper Worm Fed Watchers: Beware the Taper Worm

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Economy

Fed Watchers: Beware the Taper Worm

Following a big miss this September, analysts fear going too bold as they speculate on where the central bank will steer the economy next.

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Yes, that's a seahorse, not a tapeworm, but did you really want to see a tapeworm?(Mandy Cheng/AFP/Getty Images)

It's this week's multibillion-dollar question: Is the Federal Reserve about to ease off its all-out campaign to lower unemployment?

All year, Fed watchers have been wondering when Fed Chairman Ben Bernanke would shrink a major piece of his stimulus plan: $85 billion-a-month asset purchases intended to lower long-term interest rates and spur economic growth. The Fed has been hinting for months that it will begin scaling back—or "tapering"—the program.

 

And with a strong jobs report for November, some analysts are predicting the time to taper has come. The Fed's policy-setting committee on Wednesday will announce its next moves on monetary policy.

Taper-watch is hardly new; analysts have been speculating about the program's demise since shortly after it began. And after a big miss in September, watchers are wary of catching the "taper worm"—the creeping sense that the Fed will imminently pull back on its stimulus, despite the fact that the central bank has kept them guessing.

In September, many watchers were convinced it was time to taper, thinking the improving economic data and stable inflation meant the Fed would be ready to slightly reduce its monthly purchases. But they got it wrong: The Fed stood pat, and left its $85 billion program unchanged.

 

"People were burned by the non-taper in September, so they're hesitant … to think it's December," said Joseph LaVorgna, chief U.S. economist at Deutsche Bank. LaVorgna believes the Fed will decide to begin cutting its purchases by $10 billion Treasury bonds a month. The Fed is also buying mortgage-backed securities as part of the program, which is collectively known as quantitative easing. 

Economists at Goldman Sachs, in contrast, think the central bank is most likely to wait until spring. "We currently expect tapering to begin at the March 2014 [Fed] meeting, although a January move is very possible. We can't even rule out a small move this week," they said in a research note.

So forecasts are mixed this time around, and it's not just because those who were wrong last time worry they'll miss the mark again. The economic evidence is also mixed. The bond-buying program was supposed to help the Fed achieve its congressionally set "dual mandate" of price stability and maximum employment. Lately, gross domestic product and jobs data have bested economists' expectations, but inflation is still running below the Fed's 2 percent target.

"We think the improvement in the incoming data has been sufficient just about to warrant the taper now, but I think most people would say that this is pretty much a toss-up," said Paul Ashworth, chief North American economist at macroeconomics research firm Capital Economics.

 

"There are just times when Fed officials go into [a policy-setting] meeting and there isn't necessarily a clear outcome in sight, and they probably do have to sit down and discuss it and come to a conclusion and that debate could go either way, and I think this is one of those times," he said.

Layering onto the difficulty of forecasting the end of the program is that it's the first ever open-ended bond-buying program the central bank has ever conducted, so economists have no previous experience to draw upon. Two previous rounds of quantitative easing were discrete programs with a clear end date. The Fed said it would keep the latest up until there is "substantial" improvement in the labor force, something it has deliberately neglected to define in keeping with the open-ended nature of the program.

Many economists who do believe the Fed will begin to taper this week say the first move is likely to be small, in the realm of a $10 billion monthly cut, and that the central bank may try to offset its decision by pledging to keep its benchmark interest rate near zero for longer. Like the asset-purchase program, the goal of keeping the federal funds rate low is to encourage economic growth. The longer the Fed pledges to keep the rate low—a commitment known as "forward guidance"—the more likely businesses and households are to make the borrowing and investment decisions the Fed is hoping will bring the economy back to its pre-crisis strength. Most recently, the Fed has said it will keep the federal funds rate near zero until unemployment hits 6.5 percent (it was 7 percent in November).

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Whether the Fed decides to get the ball rolling on the taper or to wait until next year, markets may shrug. "I don't think we're going to get an awful lot of movement from markets either way," said Ashworth, who says they've probably halfway priced in the Fed's decision.

And if the Fed decides not to pull back this week, the taper worm will be back soon. The next Fed policy meeting is scheduled for Jan. 28-29, just days before Bernanke's term expires.

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