American Antabus
The Fed’s press conference this evening at 19:00 GMT marks the beginning of the end of easy monetary policy. Tapering – the scaling back of monthly purchases of Treasuries and MBS – is expected to begin with purchases falling from 85 billion to 70-75 billion a month, i.e. a taper of 10-15 billion USD. Recent housing market wobbliness means that tapering will involve Treasuries rather than MBS. In addition expect plenty of dovish sweet talk, just falling short of concrete action. Risk on would be induced by taper delay, whilst risk off would amount to a taper of >20 billion.
Quantitative easing was engineered to give the economy an extra kick, a temporary boost, as short term rates were trapped by ZLB (zero lower bound). One cannot lower nominal interest rates below zero. Never did Bernanke intend for it to become a permanent fixture, however after QE 1, 2 and ∞ cold turkey flew out of the window. Enter the taper, a gradual retreat from monetary steroids.
Tapering has been conditioned on labour market improvement, i.e. the QE dosage will be ramped up or down depending on the strength of the US recovery. Unlike in the case of the other novel Fed measure; forward guidance QE is not tied to an explicit measure of labour force activity. The result is interminable Taper chatter.
Exhibit 2 shows that the labour market has been improving consistently, although GDP growth continues to be lackluster. The macro figures should be sufficiently robust for a moderate 10-15 billion taper as advertised.
The Fed thinks that at its current pace of improvement the unemployment rate should hit 6.5 % by the middle of next year, which is still above the Fed’s estimate of full unemployment (NAIRU) at about 5.8 %. Following this line of thought monetary policy should remain accommodative until the middle of 2015 or end of 2016. Against this assessment, bond yields have jumped the gun.
There has been worry that falling unemployment is not driven by economic recovery, but rather it reflects despondent jobseekers retiring from the labour force. Exhibit 3 depicts the US participation rate, which has been falling since 1997. Hence the fall in the participation rate is mostly structural and reflects changing demographics in the US. The rise in the participation rate from 1950 onwards was driven by women joining the labour force and the relative youth of the US population.
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