Over at Tim Duy's Fed Watch, there's a marked consensus on the tapering taper talk of a few weeks ago. The point to be stressed here is not the Fed's reaction function but the market's. The blur between QE and interest rates is what caused and perhaps is still causing global jitters and flow reversals and even if the Fed realized that it jumped the gun, or that it needed to appear like it didn't jump the gun, the focus now should be on actual policy.
With the state of the labour market in mind (as it should be because essentially QE was a safety net to provide some semblance of a 'bottom' for the economy'), Duy says that three scenarios look probable
From BAML:
1) The economy converges to the labor data and the Fed starts to steadily move toward a September exit
2) The Fed thinks that reduced downside risks warrant a one-off taper (September) but then move to a wait-and-watch approach for broad-based improvement
3) The Fed plays the wait-and-watch game and doesn't move until December
Option 2 is the relative enigma here but according to Duy, "as we approach the September meeting, weak economic data will be considered less important for the outcome of that meeting relative to subsequent meetings. Barring a substantial negative turn in the data, the Fed will cut the pace of asset purchases in September, but a softer data flow may reduce the magnitude of the cut and the pace of subsequent tapering."
The problem, as evidenced by the recent reaction of the markets, is that a one-off taper followed by a pause doesn't seem to be entirely in the Fed's interest. The easiest path is a calendar path and therefore, it's possible that they start trimming their asset purchases by $15-20 billion per meeting till it hits zero by the end of the year.
Either way, it's important that the Fed convinces the markets of the distinction between QE and the path of short-term rates as policy tools - exactly how they differ in use and function. Most importantly, although it should seem more obvious than it is - a reduction in asset purchases does not and should not signal the end of the ZIRP.
What it does end up signalling, unfortunately, is an around-the-corner-possibility, which then leads to an invariable jumping of the gun. And that's why a September taper seems more and more likely.
With the state of the labour market in mind (as it should be because essentially QE was a safety net to provide some semblance of a 'bottom' for the economy'), Duy says that three scenarios look probable
From BAML:
1) The economy converges to the labor data and the Fed starts to steadily move toward a September exit
2) The Fed thinks that reduced downside risks warrant a one-off taper (September) but then move to a wait-and-watch approach for broad-based improvement
3) The Fed plays the wait-and-watch game and doesn't move until December
Option 2 is the relative enigma here but according to Duy, "as we approach the September meeting, weak economic data will be considered less important for the outcome of that meeting relative to subsequent meetings. Barring a substantial negative turn in the data, the Fed will cut the pace of asset purchases in September, but a softer data flow may reduce the magnitude of the cut and the pace of subsequent tapering."
The problem, as evidenced by the recent reaction of the markets, is that a one-off taper followed by a pause doesn't seem to be entirely in the Fed's interest. The easiest path is a calendar path and therefore, it's possible that they start trimming their asset purchases by $15-20 billion per meeting till it hits zero by the end of the year.
Either way, it's important that the Fed convinces the markets of the distinction between QE and the path of short-term rates as policy tools - exactly how they differ in use and function. Most importantly, although it should seem more obvious than it is - a reduction in asset purchases does not and should not signal the end of the ZIRP.
What it does end up signalling, unfortunately, is an around-the-corner-possibility, which then leads to an invariable jumping of the gun. And that's why a September taper seems more and more likely.
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