Here comes the Fed!
We’re mere hours away from receiving a decision on the most overhyped debate in recent memory:
“To taper or not to taper…”
Who does Bernanke think he is anyway, William Shakespeare?
The next policy announcement from the U.S. Federal Reserve’s Open Market Committee is due at 2 PM EST, followed by a live media briefing with Chairman Ben Bernanke at 2:30 PM.
But come on, people!
The Fed isn’t cutting off the sauce cold turkey. We’re talking about tapering, here – perhaps as little as $5 billion per month and no more than $20 billion per month.
So the Fed will still be propping up the market to the tune of $65 billion to $80 billion per month.
The end result? The taper obsession gripping the market is complete nonsense.
Indeed! Heck, it’s not even the most important announcement to come out of the Fed today.
So what is?
~ Fed Focus #1: It’s All About Economic Guidance
When Fed officials provide their policy update this afternoon, we’ll also get their first forecasts for economic growth for 2016.
The party line for many economists (and the Fed) has long been that the U.S. economy will accelerate in the second half of this year.
Yet that’s becoming harder to accept at face value given the following:
- Hiring recently tapered off. The economy only added 169,000 jobs in August.
- Consumers cut back on spending, with retail sales increasing a measly 0.2% last month.
- And confidence appears to be waning. The preliminary reading of the University of Michigan/Thomson Reuters Consumer Sentiment Index for September fell to its lowest level in five months, at 76.8.
Stephen Stanley of Pierpont Securities insists that “the languid August results underscore the big picture point that I have been hammering away at for a while: The vaunted second-half acceleration in the economy ain’t happening.”
Will the Fed read the data the same way? If so, it could have profound policy implications. Namely, it would warrant the Fed stimulating the economy even longer by keeping interest rates at historically low levels.
Bottom line: Any perceived economic weakness by the Fed should show up in future guidance. The Fed currently expects GDP growth of 3% to 3.5% for 2014 – and 2.9% to 3.6% for 2015.
~ Fed Focus #2: Deciphering the Real Unemployment Situation
Since the Fed launched QE3, the unemployment rate has dropped from 8.1% to 7.3%. If it falls to 6.5%, by the Fed’s own admission, it’s going to look to (finally) increase interest rates.
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However, as I’ve noted before, the drop in unemployment is a total crock. It’s been caused by more and more Americans dropping out of the workforce – not joining it.
Bottom line: Thanks to the sad labor participation rate, look for the Fed to lower its 6.5% threshold. Otherwise, it runs the risk of investors thinking the labor market is strong – and that an interest rate hike is coming sooner rather than later. And that would be downright irresponsible, given the data.
~ Fed Focus #3: Revisiting Inflation Limits
The Fed has conceded that persistently low inflation could be problematic. And that’s precisely what we’ve got.
Case in point: In April, inflation checked in at a shockingly low level of 0.9%, year-over-year. It’s now only hovering around 1.2%. And that’s well below the Fed’s stated inflation target of 2%.
Bottom line: Expectations for inflation are key for determining when to raise interest rates. So look for the Fed to dial in its guidance to also include a lower bound for inflation.
JP Morgan (JPM) suggested a level of 1.5%, below which the Fed won’t look to raise interest rates, either. We’ll soon find out if the Fed agrees, or if it has another target in mind.
The True Fed Dilemma
A Fed taper is a foregone conclusion. It’s coming within months. However, the more significant event – an interest rate hike – remains a moving target. Just ask traders.
Based on the most recent futures prices, there’s a 55% probability of the first rate hike occurring in December 2014, and a 68% probability for it occurring in January 2015. Compare that to a few days ago when the majority of traders expected the first increase to come in October 2014.
Bottom line: The true Fed dilemma is when to raise interest rates. And that decision hinges on expectations for the economy, inflation and the ever-fragile employment market. So forget about the taper. Instead, pay attention to the Fed’s announcements on these three critical issues this afternoon.
Ahead of the tape,