Jeremy Siegel, professor of finance at the Wharton School at the University of Pennsylvania, offered sage words of advice last month after frenzied market speculation as to when quantitative easing (QE) will end. “One has to understand the conditions for tapering quantitative easing are not quantitative,” he tells Euromoney.
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| Jeremy Siegel, professor of finance at the University of Pennsylvania |
Unlike the clear unemployment rate and inflation figures to which the Fed funds rate is pegged, the conditions surrounding the impetus for tapering are murky, perhaps intentionally so. This gives the Fed more leeway in determining its response – and it means no one can really know exactly what will incite them to pull the trigger. Conflating positive economic data, such as the recent rise in housing prices, with statements made by the Fed is not productive without first contextualizing them with the dynamics of the Federal Open Market Committee (FOMC).
Ethan Harris, co-head of global economics research at BAML Global Research, says the message the core members – chairman Ben Bernanke and those aligned with him – have been trying to convey is being distorted by the hawks, who have long espoused tapering and are capitalizing on the fact the core has begun to discuss it.
However, while the hawks might be getting louder, they don’t have much weight in the Fed decision-making process, according to Harris, who predicts that tapering is not going to happen at the next two meetings.
People are mixing up current data with the future outlook – and current employment conditions are not where they need to be. Though the unemployment rate has come down, it is still high, at 7.6%.
Non-farm payroll data came in at 175,000, which, although slightly above consensus, isn’t high enough, according to Harris, who thinks figures close to 200,000 are necessary for tapering.
The purchases are contingent on “improved labour outlook in the context of price stability”, according to the Fed, but these two issues can’t be examined in a vacuum.
A ballooning balance sheet and a push into riskier assets due to the low-yield environment are also weighing on FOMC members’ minds, and while these are a secondary concern, they are likely to gain traction in coming months.
Adding to this is fiscal policy that many former and current Fed members have said is working against them – and whose full effects might not have been seen yet.
However, the Fed’s ambiguity surrounding its exit also works to give it broad freedom in how it ends the programme of QE, so it can modify its strategy based on how the myriad factors play out.
FOMC members have acknowledged they would consider increasing purchases after starting to reduce. As Harris says, it’s all about finding “the right degree of pain or pleasure for the markets”.
He contends that in exiting during a period of low inflation, the Fed will be comfortable with a modest sell-off in the bond market, but will want to be gentle enough to avoid pain in the equity market.
Nonetheless, this focus on tapering has resulted in high volatility in the markets, which is likely to continue until the Fed communicates a clear message regarding its plans – but such communication is in no way guaranteed, given that the Fed is in uncharted waters.
Uneasiness now also serves the purpose of preventing future volatility when tapering begins. Siegel stressed that the market moves relative to expectations, so if investors start building in expectations now for tapering later this year, there won’t be much of a reaction if it happens then.
Ultimately, the words and actions of the Fed are jointly contorting the markets, which are critically analyzing its every move. “If the Fed doesn’t start taking a few chips off the table, then they run the risk of attracting criticism for perpetuating irrational asset price inflation,” warns one DCM banker.
“The comments are shots across the bough to remind people that this is not a one-way bet. Talking about tapering now takes away the possibility of greater volatility in the first quarter of next year, and I certainly would much rather the market had a pause for breath now. The industry will benefit from a long-term and orderly rise in interest rates.”
Still, the Fed potentially has one more issue to contend with: while monetary policy is obviously contingent on economic conditions within the US, it’s hard to ignore how its moves might play out in the global arena.
QE is full speed ahead in Japan and at a bit of a standstill in the UK, as new Bank of England governor Mark Carney prepares to take the helm, though a policy change is possible when he arrives.
The Fed’s exit from QE could be drawn on by the two when they eventually pull back. And in the nearer term, if the Fed tapers as QE is increased or maintained elsewhere, a decoupling of policies might elicit reactions in the markets if it sends interest rates moving in different directions.
There is no doubt all eyes will be on the Fed when tapering begins – but it’s looking like the 24/7 watch doesn’t need to begin just yet.