Monday, July 08, 2013

Duy on Tapering in September

by Bill McBride on 7/08/2013 06:24:00 PM

From Tim Duy at Economist's View: On That September Tapering. A few excerpts:

I think September is the date to begin tapering, and the data flow would need to turn notably downward to forestall a policy shift at that time. I think it is important to recognize that the Federal Reserve is treating quantitative easing and interest rates as two very separate policies, and each has its own relevant data. ...
[Q]uantitative easing has always been primarily about the job market and mitigating downside risks, essentially putting a floor under the economy.
More to the point, however, is that they are not entirely comfortable with quantitative easing and want to quickly bring the program to a conclusion. Hence the bar to ending quantitative easing is relative low now. They are more comfortable with zero interest rates, and thus have a relatively high bar for changing interest rates.

In short, to accept a September tapering as a data dependent decision, you need to accept that the data threshold is relatively low and differs from the threshold for interest rate policy. They are two separate policies. Consequently, we don't need to see substantially better data to forestall a September taper, but instead substantially worse data.
Bottom Line: The Federal Reserve is having a difficult time convincing market participants that quantitative easing and interest rates represent two separate policy tools. They want to severe the perception that the two are connected - a reduction in the pace of asset purchases thus does not signal a change in the expected lift-off from the zero bound. Understanding that the two policies are different is, I think, key to understanding why the Fed is heading toward a September tapering despite what many view as an overall subpar economic environment.
Duy makes a strong argument, and he is correct that market participants frequently seem to confuse the two Fed tools (it doesn't seem confusing to me).

However, Bernanke stated:
"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."
I guess it depends on what "broadly consistent" means. Clearly the economy is already under performing the Fed's forecast, and if "broadly consistent" means the lower bound of their forecasts, the economy would have to pickup significantly in July and August to taper in September. Of course "broadly consistent" could mean a fairly large miss ...

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