5 reasons the Fed wont taper


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The monetary policy in the US is closely watched around the world for the impact - sentiment driven or more fundamental - it can have on financial conditions. 

As the world economy gets increasingly globalised, central bank policies from the largest economy in the world will affect countries like India even more, given our dependence on foreign flows. 

In this context, the Fed meeting on September 17-18 is critical, since it might announce a 'tapering' in its bond purchases and hence decrease the liquidity in the system. 

But the question is: will it, wont it?

The analysts at Macro Brief put forth a number of arguments as to why the Fed will not taper. Based on their arguments, here are the 5 big reasons why it wont. 



1/ Growth has been low since the beginning of the year. Indeed, even with an upward revision of the 2Q GDP to 2.5% (QoQ annualized), GDP should increase by 3.1% in 3Q and 4Q to meet the projected 2013 growth defined by the Fed in June (ie 2.45% from 2012 4Q to 2013 4Q).

- Now, if we look at the latest statistics (retail sales, industrial production, durable goods orders…), the trend remains weak and thus far behind the Fed’s target which is partly linked to a slowdown of the buyback program. As a witness, here‘s what Bernanke said at the June press conference:
 “If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year”

2/ The signals from the residential housing market are deteriorating. The recent rise in mortgage rates (highest since April 2011) weighed very negatively on refinancing activity (13 declines recorded in the last 16 weeks) but also on new home sales (-13.4% MoM in July). There is no doubt that existing home sales should fall in August, according to the pending home sales’ decline in July (-1.3% MoM).

3/ Inflation is broadly in line (PCE inflation) or below (PCE Core Inflation) the Fed’s forecasts made in June. Anyway it remains well below the 2% target, which is the medium-term reference.

4/ Regarding the labor market, it must be recognized that since the set-up of the buyback program (September 2012), pace of nonfarm payrolls has improved whereas unemployment rate has decreased. However, the last report (August) underlines that the short term momentum of NFPs is weakening and is still below the threshold of 200K which is not a minimum acceptable for Fed:
-> Moving average 3 months: 148K
-> Moving average 4 months: 155K
-> Moving average 5 months: 164K
-> Moving average 6 months: 160K

- Also, as pointed out by the Fed members during the last Fed Minutes, qualitative indicators, namely the number of long-term unemployed (more than 27 weeks), the number of full-time jobs or the “underemployment rate”, are only improving slightly. Similarly, the decline in the unemployment rate is mainly explained by a fall of participation rate (lowest since Aug 1978) which is not a good thing.

5/ Fed communication: The Fed members have not yet defined criteria or thresholds which would impact the asset purchase program.

- Moreover, since last FOMC, almost all members (voters and non-voters) have instisted on the fact that “tapering” will be only dependent on data which were clearly weaker than expected. The last 
Beige Book confirms that activity continued to expand at a modest to moderate pace during the reporting period of early July through late August.

Read the entire report here.

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