Cacophony at the Fed

by: Peter de Bruin

Failure to taper might jeopardize credibility…

Ever since the Fed’s taper postponement, Fed officials have delivered a wide range of messages. Indeed, on Friday in a speech in New York, Esther George, who dissented from the decision to keep the Fed’s asset purchases constant at $85bn, said that a failure to ‘follow through’ with a reduction in the Fed’s asset purchases might jeopardize the Fed’s credibility. In the meantime, Dallas Federal Reserve Richard Fisher was even more blunt, stating that during the Fed meeting he had said that ‘doing nothing would increase the uncertainty about the future conduct of monetary policy and call the credibility of the Fed’s communication into question.’

 …though the decisions remains dependent on the data,…

Meanwhile, Fed president James Bullard has been more nuanced, stating that the decision had been ‘data dependent’. Indeed, according to Bullard one job report could change the way how the Fed interprets the data. In turn, this would suggest that the President of the Federal Reserve of St. Louis could favour a tapering in October, providing that September’s official labour market report, which will be released on the 4th of October, strikes a more positive tone.

…which were not yet convincingly strong enough

On the more dovish side of the spectrum, non-voting member Dennis Lockhart on Monday said that the US needed stronger growth in order to achieve a higher rate of job allocation, productivity growth and business starts up. Moreover, uber-dove William Dudley argued that although the economy was healing, the fiscal drag and the recent rise in interest rates had proven to be such headwinds, that he did not yet have the ‘confidence that the economic recovery is strong enough to generate sustained labor market improvement’.

December taper most likely, in our view

Taking a step back from all this, we continue to think that a December taper remains the most likely outcome. Indeed, in essence, Fed officials want to see three things before scaling back their asset purchase programmes. One, better labour market data. Two, evidence that the economy, and in particular the housing market, can cope with the recent rise in interest rates. And three, more clarity on Washington’s budget and debt ceiling disputes. Of these three, the Fed, at best, may have more clarity on the fiscal front when it meets on the 29th and 30th of October. Indeed, we doubt that one month of data could convince such a diverged FOMC. This, together with our view that the economy will accelerate in the remainder of this year, explains why we think that a December taper is the most likely outcome.