Fed Gains Nothing With Taper Delay
The best argument I've heard for the Federal Reserve to begin reducing the size of its monthly asset purchases (otherwise known as quantitative easing) at its Sept. 17-18 meeting is to get it over with. That's the gist of what Vince Reinhart, chief U.S. economist at Morgan Stanley, said in a research note to clients this week.
"Fed officials have already paid a high price (in terms of market volatility) for expressing their desire to see the back of QE. It is their responsibility to explain how they will extricate themselves from the program."
Tapering talk has already sent 10-year note yields up 120 basis points. Almost the entire increase has been in the real yield, not in inflation expectations. Long-term interest rates aren't about to retreat if the Fed delays the inevitable until October or December. So if rising long-term rates have policy makers tied in knots, doing nothing buys them time, not yield relief.
The real 10-year yield (from the 10-year inflation-indexed Treasury note) is 0.6 percent. JPMorgan Chase economist Jim Glassman says that before the recession and introduction of the Fed's unconventional policies, real long-term rates averaged 2 percent to 2.5 percent. The implied five-year forward real rate -- the expected real rate five to 10 years from now, which captures the anticipated normalization of monetary policy -- is about 1.75 percent, according to Glassman. "That indicates that much of the adjustment in interest-rate markets has been done already," he says.
Of course, markets tend to overshoot, and there's no reason to think they won't this time. But that's the reaction to any Fed action.
This doesn't mean "getting it over with" is a good reason to taper; it's just better than the economic justifications being offered. At the July 30-31 meeting, "almost all members" thought it was too soon to taper. What will have transpired in the six weeks between the July and September meetings? Two more employment reports, that's what. There is really no quantitative difference between an increase in non-farm payrolls of 162,000 (July) and 199,000 (April). If you don't believe me, listen to the statisticians at the Bureau of Labor Statistics.
Inflation is below the Fed's target. The jobless rate, now 7.4 percent, is being driven as much by declining labor-force participation as new hiring. And Fed officials could look at the 13.4 percent decline in new home sales in July as a harbinger and get squeamish about selling some of the central bank's stockpile of mortgage-backed securities.
Four months of tapering chatter has given wannabe sellers adequate notice. The deed itself seems fully priced into the market, and time isn't on the Fed's side.
(Caroline Baum is a Bloomberg View columnist. Follow her on Twitter.)