Taper! Taper! Taper!

by George Hatjoullis

The taper debate has become rather tedious and, as has been indicated in previous blogs, is something of red herring. Goldman Sachs economists do not think it will happen at the December 18 meeting for a lot of good reasons (http://jmp.io/T7x). The most compelling is that major policy changes are best not announced at this time as the markets are quite thin and illiquid and the reaction can be disproportionate. Moreover, waiting a few weeks is not going to make much difference so, unless the Fed actually want to add some market volatility, it would be advised to wait. The Gestaltz view is that they should have done the taper already and this would have returned the initiative on monetary policy to the Fed sooner. However, by waiting they have achieved the same although they have frustrated many investors ( well me anyway).

It is open to question whether QE as such has actually achieved much. Despite the QE, the Fed Funds rate at near zero and forward guidance that Fed Funds will stay at near zero as long as is necessary, inflation has continued to decelerate. The implication is that Fed Funds at near zero and forward guidance alone would have achieved much the same as with QE. Without QE, inflation would have been no higher (and possibly lower) so long-term interest rates would probably not have been very different to what they were under QE. Removing QE at a gentle pace whilst continuing to keep Fed Funds at near zero is not going to have much practical significance. This is especially true if the Fed also adjust downwards the proxy targets at which they will start to review their forward guidance. Unemployment is drifting lower but so is inflation. The two are being used by the Fed as proxies for the extent to which GDP is below potential. The Fed is not going to adjust forward guidance if unemployment is dropping but wages and inflation are still deemed to be decelerating. It is more likely to assume that the NAIRU is lower than previously thought, and to adjust the target unemployment rate lower. So what is all the fuss about?

Markets like to worry and agonise about the self-evident. It makes the players feel informed and self-important even though most have little clue what all these issues really add up to. In this particular case they add up to nothing. The gentle withdrawal of QE will have little practical significance in the context of forward guidance and a moderate but sustained economic uptrend. The yield curve has already largely discounted the withdrawal and getting the event out-of-the-way may boost both bond and equity prices. Let us move on.