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.

Yes, that's a seahorse, not a tapeworm, but did you really want to see a tapeworm?
National Journal
Catherine Hollander
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Catherine Hollander
Dec. 18, 2013, midnight

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).

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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