Fed to taper…gently

by: Nick Kounis

The FOMC meets this week in what promises to be a seminal event. Despite a few weaker than expected reports over the last few days, it will most likely start to taper its asset purchases. However, we expect a relatively small reduction, of around USD 15bn, taking the total monthly amount to USD 70bn from USD 85bn now. This is a touch higher than the consensus forecast (for a USD 10bn reduction) but still rather moderate. In addition, it seems likely that the central bank will amend its forward guidance to impress on financial markets that rate hikes are some way off. The most likely option to this end is to signal that rate hikes will not be considered before the unemployment rate reaches 6%, compared to 6.5% currently. This would be a soothing message for financial markets, though it seems that investors already started to factor in a more benign scenario for Fed following the weaker than expected labour market numbers in the week before last as well as Friday’s consumer data. Taking a helicopter view of the financial market reaction to Fed QE announcements more generally, most of the market impact occurred when expectations of the decision started to build, rather than when the asset purchases actually occurred. It seems likely that this will be the case as the process goes into reverse, given that we have seen significant market reactions, while the Treasury market already looks well advanced in pricing in rate hikes over the coming few years.