Tags: Fed | QE | taper | December

A December Taper?

Friday, 01 Nov 2013 08:24 AM

By Ed Moy

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The Federal Reserve announced this week that the third round of quantitative easing would remain in place at the current level of $85 billion a month. Basically the Fed cited that the economy is too weak and that it needs to see the impact of October's fiscal debacles.

For a bullish stock market addicted to quantitative easing (QE), the initial reaction was relief. But by the end of the day, gloom settled in. The view that the Fed was signaling that tapering of QE might happen as soon as December 2013 had gained momentum and continues today.

The chances of a December taper are unlikely, but possible. If the economic data from October and November point to a flat or improving economy despite the hit from October's fiscal debacles, the Fed could make the argument that the economy is strong enough to start standing on its own. But aside from the Fed's economists, few believe that the economic recovery will strengthen considerably in the near future.

The odds are much better against a December taper. The Fed clearly stated its twin targets of an unemployment rate of 6.5 percent and inflation of 2.5 percent have clearly not been met.

Unemployment has been inching down slowly and for less-than-good reasons. Instead of well-paying, full-time jobs, most of the new jobs created are low-paying and part-time. And the numerator has gone down because a record number of Americans have stopped looking for work, which creates a distorted reduction in the unemployment rate. Inflation is stubbornly stuck at 1.5 percent with more economists concerned about deflation than inflation.

If the Fed intentionally signaled the possibility of tapering sooner rather than later but the data do not support it, then what were the reasons?

The reasons are likely twofold.

First, for a bullish stock market addicted to QE, the scare of tapering would let some air out of the bubble and make the inevitability of tapering less harmful.

Second, threatening to taper could be another warning to President Obama and Congress to get its fiscal act together by their self-imposed January deadline.

It is clear that the Fed does not want to continue QE much longer: the QE program is having a significantly diminished positive impact on the economy and is getting too large to unwind without harm to the economy.

Contradicting the herd mentality, it is unlikely that the Fed will start to taper its QE program this year.

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