Not to taper…a relatively close call

by: Peter de Bruin

Economy not yet strong enough to taper,…

The minutes of the Fed’s September meeting, in which FOMC members, against expectations, decided not to scale back the Fed’s asset purchase programmes, painted a picture of a divided Fed. Indeed, FOMC members were torn between competing considerations. One the one hand, members thought that the data was not yet pointing in the direction of a strong enough recovery. Meanwhile they also feared that an announcement of a reduction in the pace of asset purchases could trigger ‘an additional, unwarranted tightening of financial conditions’, as the move could be interpreted by markets as a first step towards an exit from the Fed’s highly accommodative policy. Furthermore, members feared that the risks surrounding fiscal policy could hurt the growth outlook. As a result of these concerns, it was seen as ‘prudent’ to await further evidence of recovery.

… though members feared a communicational backlash

On the other hand, as financial markets had generally expected the Fed to take a first step, members feared that not scaling back the Fed’s QE programmes could hurt the effectiveness of the Fed’s future communication, while there was also concern that it might convey ‘a message of pessimism’ regarding the economic outlook. As such, although they only favoured a ‘relatively small’ reduction to signal the FOMC’s intention to proceed ‘cautiously’, members could see the merits of the Fed reducing its asset purchases. In the end, the decision not to taper the Fed’s asset purchase programmes was therefore ‘a relatively close call’ for several members.

A ‘Dectaper’ remains on the cards, barring a protracted fiscal impasse

Taking everything into consideration, the minutes were a bit less dovish than we had thought. Indeed, in our view, a slight acceleration of the data would give FOMC members enough reassurance to prompt them to begin curtailing their asset purchase programmes. As such, we continue to think that a tapering in December remains the most likely option. That said, a protracted government shutdown, taken together with a hostile debt ceiling debate that erodes consumer and business confidence, could easily keep the central bank on the side-lines, as it would prevent the economy from accelerating in Q4. As this would force the Fed to await more evidence of a stronger recovery, it would probably push the first reduction in the Fed’s QE programmes out to the March meeting of next year.