All Eyes on the Fed Taper

By Leith van Onselen, Chief Economist of Macro Investor, Australia’s independent investment newsletter covering trades, stocks, property and yield. You can follow him on Twitter at @leithvo. Cross posted from MacroBusiness

It’s all about the FOMC meeting at 04:00 AEST tomorrow morning and to be honest nothing else really matters. Ben Bernanke speaks 30 minutes later at 04:30 AEST and the chairman’s speech will also be highly watched, potentially increasing volatility across the board.

Data in the US has been OK, but hardly enough to warrant a sizeable cut to its $85 billion a month bond buying program. The two key metrics which the Fed pays attention to, given its dual mandate, are price stability and full employment, and nether are brilliant. With the 160,000 jobs created on average over the last six months is 40,000 below Chicago Fed president Charles Evans target of 200,000. Core PCE at 1.2% is also significantly below the Fed’s longer term target of 2.5%.

There are three things that are fundamental to tonight’s meeting. The first is how much (if at all) the Fed will lower its asset purchase program? As things stand we feel the market is pricing in a $5 to $10 billion cut in the pace of the buying, although there are different thoughts as to whether this will be solely limited to US treasury buying or both US treasury and mortgage-back security buying. Any more than $10 billion should be USD positive and negative for equity and bonds (yields up). Gold and equity bulls will be hoping the bank don’t cut at all, potentially signalling it could happen in December. We feel the risk is that tapering will actually be announced tonight, but actually start in October, so the Fed has more time to smooth over any volatility this may cause.

Point two is around the Fed’s economic projections, which also come out also at 04:00 AEST. The risk that the Fed cut its real GDP forecasts is clearly very real and we would not rule out a change in forecasts to 2.2% (from 2.45% in June) for 2013 and 3% in 2015 (from 3.25). The board provides its first estimate for 2016 growth, which we feel should range between 2.5% and 3%, and this will be interesting because it is potentially the first read that includes how growth could be impacted by a hike in the Fed funds rate, which the Fed should detail in its forecasts as well. The Fed will also look to alter its core PCE inflation rate, while unemployment could also be tweaked through to 2016.

The third point, and in some way the most important for markets, isn’t the size of tapering; it is more about its forward guidance framework around what will be the triggers for a rise in the Fed funds rate. This is where the real action in commodities, the USD, fixed income, emerging market currencies and equities could materialise. This is where the Fed will need to anchor expectations.

The Fed currently would look to hike the funds rate when the unemployment rate is seen hitting 6.5%, and this should still remain in place. There is a possibility we see the Fed provide clarification that the 6.5% unemployment threshold for putting up rates is conditional on inflation trending to the 2%, although we feel this is largely priced in. What is not priced in and would cause a 15-20 basis point reaction in the US ten-year to the downside, would be if the Fed cut its employment threshold to 6% (from 6.5%). This, in theory, would push back on future rate hike expectations by around eight to nine months and would cause AUD/USD to rally to 0.9500, cable to smash the 1.60 barrier, gold to rally $50 and cause US equities to easily break all-time highs. Emerging markets would also love this. The chance of this happening though is low, and the market is not positioned for this action.

The Fed has tried so hard for so many months to separate the distinction between the tapering process (and thus its balance sheet) and a move in interest rates and tonight this will come in front and centre. All the market sees thus far is that tapering is a start of a normalising process and we feel the Fed’s message will again be reiterated loud and clear. They will ramp home that a tapering exercise is a reflection of the economic strength; however it is in no way a start of a normalisation in rates. In theory the economic projection really does matter then, because if the Fed cut its 2016 unemployment rate from 5.5% to 5.2% (we think it could be higher though) they will probably have to lower the employment threshold to 6% and, as previously mentioned, this should be a risk positive affair.

As detailed as we feel the risks are, the Fed actually verge on the dovish side, which in theory is good for gold. However, price action is not convincing at all and a daily close tonight below $1307 (the 50% retracement of the June to August rally) would see us suggest new shorts on gold. This would also coincide with the daily MACD firmly below zero.


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  1. craazyman

    it was probably a mistake to have bought as much GLD as I did, but at this point it might be too late.

    Is Bernanke Montezuma himself? All the tribe transfixed, immobile, brains blank as a test pattern until the Big Man raises his fist one-half an inch and points at the pyramid?

    The everybody lets out a scream that would make your blood turn to ice. 1000 maniacs in face paint and feathers ready for blood.

    If you’re in GLD , it’s your blood. This wasn’t the way we planned it. This was supposed to be a get rich quick scheme, and now your laying like a lamb over the pyramid’s stone point, your throat in the air.

    Maybe you’ll still get lucky. What’s up with all these jobs. I hear Dunkin Donuts is hiring. it may yet come to that for me, anyway. Since getting rich quick isn’t working. I might have to. They always say it’s good to love what you do. I like donuts so maybe that’s close enough.

    What about some other 10-bagger? Can you recommend something that goes up no matter wat Bernanke says?

    1. from Mexico

      craazyman said:

      What’s up with all these jobs. I hear Dunkin Donuts is hiring.

      Really! The FOMC truly has left this world and ascended into Cloud-Cuckoo Land, and they’ve taken traders like Leith van Onselen with them.

      No one has ever put it more eloquently than the Mexican writer Carlos Fuentes:

      The country was threatened with an acute case of schizophrenia. A minority centered their lives on the New York Stock Exchange, and a majority on the price of beans. One economy was all gilded wrapping paper, the other all huts and untilled land. The former was the minority’s, the latter the majority’s.

      It was Paul Volcker, under the influence of Milton Friedman, who disconnected the Fed from any worldly reality and thus set the Fed on its present course of mayhem and destruction. The cognitive dissonance is deafening, such as in statements like this one, as if the supply of money could somehow exist on some separate planet apart from the price of money:

      The Fed has tried so hard for so many months to separate the distinction between the tapering process (and thus its balance sheet) and a move in interest rates and tonight this will come in front and centre.

    2. craazyboy

      Montezuma’s Revenge will be when we find out GLD doesn’t have any gold in it. That’s why I never bought any.

      Good idea about Dunkin Donuts, but after increasing the Fed balance sheet to close to $4T, Dunkin Donuts is still only hiring part time. Sorta makes you wonder what the connection is?? I mean if your not an economist that understands that sort of stuff.

      The only 10 bagger I can think of is 10 bag ladies.

      1. ambrit

        Dear craazyboy;
        “..ten bag ladies.”
        This one is so target rich I’m embarrassed. My first thought was; “You mean the “Bag Ladies” who collect the pay offs every Thursday for the Administration?” (My Dad worked in City Hall for a while. That ‘mysterious’ fire in the Judges house one Friday afternoon comes to mind.) Perhaps it’s time to invest in shopping carts.

    3. psychohistorian

      If you would have moved all your Treasury holdings to GLD , as I did in 2008, you would still be way ahead of the game and watching/hearing the printing presses running.

      IMO, which is not worth the electronic white noise it creates, I would invest in the safest commodities I could find until the US dollar bubble pops… need to make structural investment decisions based on how you see the future unfolding.

      Pass the popcorn.

      1. skippy

        The only problem with hording (cumbersome) is stealth, mobility and flexibility.

        skippy… what price will potable water or life saving pharmaceuticals fetch, in various dystopia’s, against paper promises or stuff that just sits there.

  2. financial matters

    The unemployment number seems to be a ruse. It doesn’t take into account the quality of jobs or the lack of benefits let alone the real numbers..

    From ZH ‘Real Unemployment Rate: 11.3%’

    “”By now the trick of lowering the unemployment rate courtesy of a “collapsing” labor force participation rate is known by all.

    What is laughable is that for all talk of demographic issues, the big drop started with the Great Financial Crisis, and has barely bottomed. This is even more laughable when one considers that it is the older workers, or those who supposedly should be retiring if one buys the propaganda narrative, who have seen the bulk of job gains in the past 5 years.

    In short: this is merely a favorite BLS gimmick to push the unemployment rate lower for purely political reasons (to the benefit of the administration

    So how does the narrow unemployment rate (U-3, not to be confused with the wider, Underemployment U-6 rate) look if one applies a longer-term average Labor Force Participation rate of 65.8%?

    In a word: not pretty. As of May, assuming realistic LFP assumptions,the real U-3 unemployment rate should have been not 7.6% but 11.3%””


    I thought one of the recent links had a better handle on the real reasons for tapering

    5 Reasons For The Fed To ‘Taper’ That Have Nothing To Do With Economic Data Clusterstock

    which includes frothy markets and lack of effectiveness..

    and includes the fact that ‘Because Treasuries – one of the few remaining AAA-rated financial assets on the planet – are used as collateral in a host of transactions throughout the financial system, continued Fed purchases at the current monthly pace as issuance declines could weigh on the financial system’s ability to lend and lead to an increased risk of further destabilization in the Treasury market.’

    So they have better uses than to be added to the Feds’ balance sheet or continue being substituted for MBS and to recapitalize fraudulent banks.


    This was a recent encouraging report..

    UN Conference on Trade and Development: Report 2013

    “”Fostering the purchasing power of the population is a key element in this regard. It can be achieved through an incomes policy, targeted social transfers and public sector employments schemes. Income creation and redistribution favouring lower- and middle-income households is crucial to this development strategy, because those households tend to spend a larger share of their income on consumption, particularly of locally or regionally produced goods and services.

    It affirms that central banks should enlarge their mandates beyond inflation control and, through a credit policy, play a much more engaged role financing the real economy. The implementation of such a credit policy can be facilitated through the involvement of specialised institutions, including national and regional development banks. Indeed, a network of specialized financial institutions may be more effective in channeling credit for development-enhancing purposes than big universal banks, which tend to become not only “too big to fail” but also “too big to regulate”.””

    1. TC

      Good stuff, particularly the UN report. Now, how to turn talk of central banks issuing credit for something other than backstopping hopelessly insolvent albatrosses into concerted, effective action…

      Business Insider’s point about “continued Fed purchases at the current monthly pace as issuance declines could weigh on the financial system’s ability to lend” makes sense, but how this would destabilize the Treasury market is unclear. My sense is part of the Fed’s purpose in the grand scheme of things has been in fact to set up the Treasury market’s destabilization. As the periphery of the trans-Atlantic banking system finds an ECB already succeeding at destabilizing sovereign credit markets in Europe, it’s only a matter of time before the Fed succeeds doing the same.

  3. Jim Haygood

    Scott Minerd of Guggenheim points out just how severe the Bernanke Bear Market in bonds has been:

    The increase in U.S. Treasury yields of more than 115 percent since their bottom in July 2012 is greater on a percentage basis than any cyclical increase from trough to peak in the past 50 years. Previously, the largest such increase was 94 percent between December 2008 and April 2010.

    With history as our guide, we are now only days from the average length of such bear markets. The average time from trough to peak is 423 days. Now as Fed policymakers meet to discuss tapering asset purchases, it has been 420 days since rates last bottomed in July 2012.

    Offering a note of hope, Minerd suggests that ‘Once rates peak, the average decline of the previous sixteen interest rate cycles is 35 percent. That means, if 3 percent was the top of the current interest rate cycle we could expect rates to fall below 2 percent before another meaningful sell-off.’

    He also lays on a rather stunning indictment of Da Bernank:

    Dr. Bernanke’s expected January 2014 departure as chairman after eight years overseeing unprecedented growth of the Fed’s balance sheet may have left him with an urgent desire to show an exit strategy. Were it not for his impending exit, I suspect he would have otherwise let the economic data unfold for another three or six months before considering tapering.

    Central planning — don’t attempt it at home, kids!

    1. Jim Haygood

      If today’s post-Fed action represents an inflection point, then Scott Minerd might have nailed it to the day — bonds cranked like m*****f*****s after the pronunciamento!

    2. MikeNY

      LOL, I love your posts.

      As Grantham says, the Fed is going to flog the mule of the US economy until it becomes a racehorse … or until it drops dead.

  4. curlydan

    If you want to see a scary chart, pop open the trends in the Fed balance sheet and set the start date to about January 2008.

    The compounded annual growth rate in the size of the Fed’s balance sheet from Sept 3 2008 (yes, I’m cherry picking the date here) to today is 32%.

    The growth in the last year alone is 29%. And this chart doesn’t even show the scary composition of the assets, chock full of MBS.

    The growth is so fast that the caption above the graph is woefully outdated, saying the balance sheet is well above $2 trillion…it’s now closer to $4 trillion than it is to $2 trillion

  5. Edward Lambert

    The economy is not going to make it to 2016. A lower labor share has lowered the threshold for when a recession would happen.
    The economy is not heading toward a recession at the moment, but within the year, we will see indicators showing a change.

    A lower labor share means a lower equilibrium level for real GDP.

  6. Fiver

    With Bernanke’s “No taper” today, he has earned himself a prominent position up front in the Hall of Shitheads.

    1. James Levy

      Where will the money go? How far can you pump up the price of stocks when the companies those stocks represent are crawling along at a snail’s pace?

      The money men poured capital into buying up distressed properties, only to find out that the peons can’t afford rents that will make those properties the cash cows they were sold as. They’ve been pouring it into stocks.

      With incomes flat they can’t plow the money into plant and equipment, and the private sector doesn’t seem to want to do R&D on a big scale any more. So where the hell does that $85 billion a month go?

        1. James Levy

          Correct me if I am wrong, but there used to be this concept known as the velocity of money. The more a given sum of money changed hands, the theory went, the more economic activity it generated and the better off we all were.

          Dumping money into the stock market (or into the hands of people with a huge marginal propensity to save, i.e. the rich) doesn’t spur economic activity at all. What the fuck is Bernanke thinking? That everyone with a 401k is going to spend every dime they have plus max out their credit cards and HELOCs because the value of the stocks in their retirement accounts are growing? No matter how many advanced degrees these people have from what fancy-pants universities, if they can’t understand this, they are STUPID.

        2. psychohistorian

          We are Japan 2.0…..that is right as far as it goes but we are also the Reserve Currency.

          The US dollar bubble is blowing bigger and bigger and bigger….try not to have too many dollars when it pops.

  7. Conscience of a Conservative

    I’m surprised that the Fed opted for more of the same, especially on the MBS side. With issuance down, the Fed will be the market and crowd everyone else out, and worse yet reduce liquidity for the exising players by removing product from circulation. Very dangerous from the perspective of a functioning market. And of course this means that banks filling TBA’s keep more of the profit.

    1. Conscience of a Conservative

      Additionally Fed Q.E. has allowed Verizon to borrow cheaply at what is essentially junk bond financing which ultimately got allocated to retail accounts. Bernanke should be ashamed.

  8. NotSoSure

    I am not sure why people are surprised. The Fed will never taper. In fact I am sure QE will be increased next year.

  9. Massinissa

    QE is the only thing keeping the ponzi scheme of modern financial capitalism from collapsing like the fragile house of cards it is. The PTB are not so stupid as to let the house fall… Yet.

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