Taper returns!

My base case for a Fed taper is mid next year. But Friday’s US data continued a good run of upside beats and, given the taper is the only game in town for asset prices, we should remain vigilant.

The very important ISM (essentially the US PMI) was again strong:

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There is no weakness at all in there and no sign of the shutdown. Just to confuse things, these days there is also a generic Markit PMI which was less favourable, showing a sharp drop in production on the shutdown, but it’s the ISM that matters.

As a consequence, long bonds sold off sharply with yields up 2%:

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Stocks rallied too, half a percent, on the hope that the ISM is wrong. So, where is this data going and is it enough to revive an imminent taper? Calculated Risk offers the following guidelines:

1) The unemployment rate probably increased sharply in October (due to the shutdown), but the impact of the shutdown will be reversed in the November report that will be released on Friday December 6th.  If the unemployment rate declines back to 7.2% or so in November (the September rate), then the FOMC might taper.

2) As Merrill’s Hanson noted, the FOMC would probably also be looking to see employment growth close to 200,000 in the November report.   If the year-over-year change in employment is still around 2.2 million for November, the FOMC might taper.

3) The FOMC is also concerned that inflation is too low. From the October FOMC statement:

The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.

The PCE price index for October will be released on December 5th (the September PCE index will be released this week).  If PCE prices are moving back towards 2%, the FOMC might taper.  Note: CPI for November will be released on December 17th and might influence the decision.

4) On fiscal policy, the budget conference committee is scheduled to present an agreement on December 13th (just before the FOMC meeting).  The committee is expected to play “small ball”, so it is possible an agreement will be reached.  If a reasonable agreement is reached (hopefully reduce the impact of the sequester in 2014), then the FOMC might be more inclined to taper.  If it appears that the House might shutdown the government again, the FOMC will be inclined to wait.

If the Fed was nervous enough to wait in September then any circumstance without a fiscal resolution is a no-brainer hold. As well, data is beginning to flow through now showing the impact on home construction of the past few months of headwinds and it’s looking like a pretty sharp fall, adding to recent weakness in pending home sales. Also from Calculated Risk:

Builder results so far strongly indicate that the combination of higher mortgage rates and aggressive home price increases resulted in a significant slowdown in new home sales last quarter. While the relationship between large builder results and Census estimates for new home sales is far from perfect (partly reflecting market-share changes but also reflecting methodological and timing differences), these builder results suggest that Census estimates for new SF home sales for September (re-scheduled for release, along with estimates for October, on December 4th), could be down sharply from August.

This data is the equivalent of the HIA in Australia and is reliable enough.

Before we get too complacent going even longer equities, currency markets also reacted to the Friday data flow by aggressively bidding up the US dollar more than half a percent and it is threatening to break out on the chart:


Everything undollar was hit with the Aussie and gold down half a percent and oil down almost 2%. Some of this heat is also coming from a growing expectation that the ECB will cut rates this week.

At this point, then, my view is unchanged that taper is March at the earliest. These shutdown events have a strange impact on the economy. Demand hiccups briefly which sends a little shock through the supply chain, which pauses, then the cash starts to flow again and there’s a little hill of pent up demand to service just as inventories flatline. Production then has to catch for a quarter or two.

In short the data should be decent running into Christmas but underneath that I still US housing slowing too fast for the Fed’s comfort. Unless there’s a fiscal settlement that removes fiscal drag in 2014, which seems very unlikely at this point, equities can still rely on the Fed put, though as the data flows you’d expect some nerves.

Houses and Holes
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  1. Diogenes the CynicMEMBER

    I still think no taper. If they do try it it will be a tiny, tiny step and then when they see the results they will return to their current strategy.

  2. Taper or not to taper is not the question. How far can the fed’s balance sheets grow, from current US 3 Trillion?

    I think the temper will go on till it reaches upmost limits. With no legislation to limit the fed books, it can go on for many more years.

    • The Fed is buying almost all of the net new debt of the US government.

      If the tea party get their way and the deficit shrinks further in 2014, Fed will have no choice but to taper!

      • Since the start of the GFC, foreign central banks have decreased their holdings of US Treasury debt from 25% of the debt to 19%.

        Meanwhile, over the same period of time, the Federal Reserve has increased its holdings from 5% of US Treasury debt to 21.25%…the graph is looking a little exponential since QE3 started in October 2012.

  3. Interesting take – I thought last weeks moves were mainly to do with the low EURO CPI print, which the market responded to by pricing in a rate cut or new round of LTRO or similar.

    EUR sold heavily and as a consequence USD was bid up through Thursday and Friday.

  4. There will NEVER be a ‘taper’. If you think there will be, you believe in the tooth fairy.
    You were wrong in September (there was no ‘taper’) Macrobusiness are no better than the CNBC sheep!
    Oh and some people said gold would fall to $700-900 YOU ARE WRONG! Hahahaha!

  5. Glad to see that the RBA has turned around and started to ‘taper’ it’s holdings of US Treasury Securities.

    A few years ago it held as little as USD12.1Bn, but as recently as April the RBA had USD38.5Bn.

    By August this year it has tapered down to USD32.9Bn.

    We can only wonder if Glenn Stevens was so in awe of Ben Bernanke that he had his arm twisted into buying such a large amount of risky debt…or perhaps he thought he would make a killing by selling them all when our dollar magically goes down to USD 0.80.

    I hope savers like myself aren’t being sacrificed at the altar of getting our dollar down to make this gamble pay off.

    • What makes you think they’ll blink an eyelid for your savings? The leveraged are far more important to the australian economy than the savers. Our banks don’t run on your savings, they run on money they borrow from other banks. Priority 1 is to keep the bubble inflated. AUD is almost at 95c, I’d cash at now.

  6. I personally can’t see a taper, the FED is caught in a liquidity trap, even Larry Summers admits that. If anything the QE program will expand.

    • Yeah, in one week in November 2012 (just after QE3 started) the foreign central banks sold 11% of their holdings of US Treasury debt… a shot across the bow.

      So when Chair Yellen increases QE next year you would expect a similar response from foreign central banks…and of course the Fed would then have to take up the slack.

  7. I would be surprised to see taper before March: data not yet convincing; more shenanigans to come in Congress; fear an loathing at impact in EM’s…and Yellen.

  8. No way will they taper, as Max Keiser so eloquently said :

    “You can’t ‘taper’ a Ponzi scheme… You can only increase it.”

  9. http://www.counterpunch.org/2013/11/01/does-the-dollar-have-a-future/

    “Naturally, this loss of confidence is going to hurt the dollar vis a vis its position as the world’s reserve currency. But don’t kid yourself, China and Japan want to be the top-dog either. They’re fine with the way things are right now. The problem is, it’s looking more and more like the US is not up-to-the-task anymore given the irresponsible way it conducts its business. And we’re not talking about the government shutdown either, although that circus sideshow certainly lifted a few eyebrows in capitals around the world. Foreign leaders have come to expect these tedious outbursts from the lunatic fringe in Congress. But, the fact is, the government shutdown fiasco had very little effect on the bond market. The benchmark 10-year US Treasury shrugged off congress’s screwball antics with a wave of the hand. No big deal. Not so the talk of “tapering” by the Fed, which sent 10-year yields soaring more than 100 basis points to 3 percent in less that a month. Tapering put the fear of god in everyone. The sudden jolt to mortgage rates was enough to put the kibosh on new and existing homes sales putting a swift end to Bernanke’s dream of reflating the housing bubble. The rising long-term rates threatened to push the economy back into recession and wipe out five years of zero rates and pump priming in the blink of an eye. That’s why China and Co. started to jettison USTs. They figured if the Fed was going to scale back its asset purchases, rates would rise, and they’d be left with a whole shedload of US paper that would be worth less than what they paid for it. So they got out while the gettin’ was good.

    So don’t believe the media’s fairytale that Bernanke postponed tapering because the economy still looked weak. That’s nonsense. It was the selloff in USTs that slammed on the brakes. The Fed actually wants to reduce its purchases because there are humongous bubbles emerging in financial assets everywhere. But how to do it without triggering another crash, that’s the question. The Fed has distorted prices across the board, which is why the main stock indices are climbing to new highs every day on the back of an economy that has less people in the workforce than it did 10 years ago. What a joke. And people wonder why foreign lenders are getting nervous?”