Overnight market action shows that nobody really has a clue about the Fed taper any longer. Stocks fell, suggesting it’s on. The US dollar and gold both rose marginally suggesting it’s on and off. Treasuries were bid suggesting it’s off. One night’s action is not the be all and end all but it is indicative of where we are at.
The stimulus to these various moves came from three different Fed speeches, which were just as confusing. William Dudley, a voting member and noted dove, spoke and made his intentions very clear:
To begin to taper, I have two tests that must be passed: (1) evidence that the labor market has shown improvement, and (2) information about the economy’s forward momentum that makes me confident that labor market improvement will continue in the future. So far, I think we have made progress with respect to these metrics, but have not yet achieved success.
With respect to the first metric, we have seen labor market improvement since the program began last September. Over this time period, the unemployment rate has declined to 7.3 percent from 8.1 percent. However, at the same time, this decline in the unemployment rate overstates the degree of improvement. Other metrics of labor market conditions, such as the hiring, job-openings, job-finding rate, quits rate and the vacancy-to-unemployment ratio, collectively indicate a much more modest improvement in labor market conditions compared to that suggested by the decline in the unemployment rate. In particular, it is still hard for those who are unemployed to find jobs. Currently, there are three unemployed workers per job opening, as opposed to an average of two during the period from 2003 to 2007.
With respect to the second metric—confidence that the economic recovery is strong enough to generate sustained labor market improvement—I don’t think we have yet passed that test. The economy has not picked up forward momentum and a 2 percent growth rate—even if sustained—might not be sufficient to generate further improvement in labor market conditions. Moreover, fiscal uncertainties loom very large right now as Congress considers the issues of funding the government and raising the debt limit ceiling. Assuming no change in my assessment of the efficacy and costs associated with the purchase program, I’d like to see economic news that makes me more confident that we will see continued improvement in the labor market. Then I would feel comfortable that the time had come to cut the pace of asset purchases.
I’ve no doubt that Congress will gets its act together sooner or later so that’s only a delay. Any further fiscal tightening is likely to be manageable but prevent domestic economy acceleration. The improvement in employment is fundamentally questionable and if it is going to require a fair dinkum fall to lower levels for tapering to begin then it’s possible we’ll never see it. The current talk of such has already been enough to knock the stuffing out of the US housing recovery and I expect data on that front to continue to deteriorate. We are also likely near the peak in data surrounding the global rebound with China still not producing any self-sustaining growth dynamics and Europe’s recovery slowing in the second derivative. Whether a triumphant Merkel steers back towards austerity now is also a vital question. Another Fed president, Dennis Lockhart, added that he already saw signs of slowing in the US jobs market.
Meanwhile, non-voting hawk, Richard Fisher declared that the Fed’s credibility had been undermined by the failure to tighten, didn’t reflect the discussion at the policy table and added uncertainty to markets and the economy.
I’ve backflipped once already on the taper. Originally I saw it as unlikely owing to the blowout in bond yields and effects on the housing recovery. The red hot run in ISM data persuaded me otherwise. Also, it seemed to me, since markets had priced it already, the Fed had nothing to lose in pulling the trigger. Now, the data flow henceforth is increasingly unlikely to support tapering with bond yields very likely to suppress the US recovery and the global bounce approaching its peak as well. It seems likely that the Fed has missed its window.
Then there are others, like Martin Feldstein, arguing at the FT that QE is doing nothing now anyway:
Although the initial burst of bond-buying may have helped to stimulate demand in 2010 and 2011, the current strategy is now doing very little to stimulate economic growth and employment. At the same time, continuing to buy long-term bonds and promising to keep the real short-term rate below zero even after the economy has returned to full employment have serious costs. They distort the investment behaviour of individuals and institutions, driving them to reach for higher yields by taking inappropriate risks. They lead banks to make riskier loans in order to get higher returns. The longer this process of abnormally low rates continues, the more disruptive will be the return to normal conditions.
According to Bernanke some months ago, the taper was designed to prevented a build up of leverage in the cycle. That was code for putting a lid on asset markets. That has been achieved in financial markets and most likely housing as well over the next six months. However, Feldstein is wrong when he says this won’t slow growth and the jobs market, and so tapering is off.
In other words the confusion is systemic and is the new normal.
