Date: September 18, 2013

Taper Talk

Why does it seem like every single Fed meeting has become “the single most important FOMC meeting ever” in the media? And here we are again. The Fed begins a two day meeting tomorrow and it is widely expected that they will announce the first of many subsequent tapers at either this meeting or the one in November. The only surprise will be if they remove any kind of taper talk from their announcement or commentary. Although I do not agree with tapering at all here, consensus believes the Fed probably begins with a token taper of $10-$15 billion per month skewed towards treasury bonds. If they don’t, something else is at play in Bernanke’s mind.

As you would expect, the financial markets probably have a very negative response if the taper is more than $15 billion. If the taper is as expected, I think you will see moves in both directions until Bernanke’s press conference ends at 3pm and how he couches future tapers. If they surprise without a taper, I would expect a very positive immediate response that would run the stops in at the old highs.

Currently, the Fed is buying $85 billion a month in mortgage back securities and treasury bonds to keep interest rates, specifically mortgage rates, artificially low. That, in turn, helps the housing recovery which is so vitally important to the economy. Equally as important, the printing of $85 billion per month has resulted in dramatically higher stock prices because investors have been almost forced into other investments as bond yields plummeted, not to mention the additional torrent of liquidity in the system.

Should the Fed taper? Should they not taper? How much? When?

There is no right or wrong answer. Once the Fed Funds rate dropped to 0%, Bernanke & Company were forced to use other monetary tools. Printing money has similar results as lowering rates, so in this case, interest rates have effectively been below zero for some time. By beginning the process of ending QE, the Fed is returning rates to 0% for an eventual move to 0.50% and above much later this decade.

I completely understand those who believe the Fed’s hand is too heavy in the market. Forget about the thumb on the scale; Bernanke has his hand, wrist, elbow and arm on it. By that token, those people would rather let what’s left of the free market to rise and fall where it may. No arguments here.

On the other hand, we have an economy that is performing like almost every other post financial crisis period with sub par growth and stubbornly high unemployment. Since our elected clowns in Washington cannot get any fiscal policy passed, the Fed has become the juice of last resort. In effect, the Fed is plugging dykes and adding sandbags until the waters hopefully subside down the road which I continue to believe to be after the next recession.

We cannot have it both ways. I believe that tapering will drain liquidity and adversely impact the markets and economy over the intermediate-term. But long-term, we will be in excellent shape. The quicker we taper, the closer we come to recession and eventually get to the other side. But that comes with pain. Staying the course prolongs the markets’ and economy’s addiction to the crack of QE but prevents more serious short-term injury in hopes of an eventual fiscal solution from Washington.

Take your pick.


Paul Schatz, President, Heritage Capital