It’s Still Too Early To Worry About The Fed Tapering

Fed tapering will be a legitimate worry in a few months, but should not be yet. Analysts and economists have been concerned for almost five years now about how Fed Chairman Bernanke would ever be able to manage a successful exit from the Fed’s massive QE stimulus efforts.

But markets have not been concerned since the summer of 2011. At that time QE2 was scheduled to expire at the end of June, and the Fed allowed that to happen. The S&P 500 topped out in May, 2011 and plunged 19% to its October low. The Fed has not taken such a risk since.

In seeming panic, the Bernanke Fed rushed to the rescue with “Operation Twist” on September 21, 2011, in which the Fed began selling $400 billion of short-term bonds, and used the revenue to buy longer-term bonds. That new stimulus program reversed the market correction on a dime. The market has not experienced even a 10% pullback since.

There was a brief pullback in the spring of 2012 on concerns that Operation Twist was due to expire in June. But the Fed quickly extended Operation Twist, and followed that up with a new stimulus program, QE3, last September.

The result was that last fall the stock market launched into the powerful new leg up that ran through last winter and continued even through the market’s unfavorable summer season this year.

It did pull back briefly a couple of times this year, again on Fed worries.

But this time the Fed was very cautious, just testing the waters. It hinted in May that it could begin tapering back its QE stimulus as early as June. However, when the market sold off Fed Chairman Bernanke rushed in to provide assurances that tapering will not begin until the economy can handle it. The market rallied back to new highs. The market stumbled again in August on concerns the Fed was hinting it might begin tapering at its September meeting. But the Fed announced its ‘no taper’ decision after that meeting, and the market recovered again, rallying back to still higher highs.

The Fed is treading very cautiously, and yes, it has the market back on taper concerns again, because its statement after this week’s FOMC meeting included the phrase that “economic activity has continued to expand at a moderate pace.” Markets were hoping for an indication that the Fed is more concerned about the slowing economic reports, and thus not still considering tapering.

The expectations prior to the meeting were that tapering was off the table until at least next March, and possibly as late as June.

Now expectations are back that tapering could begin as early as the December meeting.

That is highly unlikely for a number of reasons.

To begin with, the December and January FOMC meetings will be Bernanke’s last, the end of eight years of his governance. It’s improbable that after launching the stimulus and keeping it going all this time, he would make the major decision to begin tapering it back as his final act in his last two months in office, leaving it up to his successor to deal with the correctness of the decision and any fallout.

In addition, let’s not forget that the spending bill and debt-ceiling crisis were only kicked down the road to January and February. The Fed has admitted its concern over how Congress’s first go-around on those situations would work out played a hand in its ‘no taper’ decision at its September meeting.

So unless the economy forces its hand with a dramatic upturn of positive reports including a big turnaround in recently slowing employment, and in the slowing housing recovery, the new market worries about the Fed tapering earlier than next spring are quite likely misplaced.

And so far the economy seems to be cooperating. This week’s reports included a 5.6% decline in Pending Home Sales in September, a sharp decline in the Dallas Fed’s Mfg. Index from 12.8 in September to 3.6 in October, a decline in retail sales in September (the first monthly decline in six months), a sharp decline in the Conference Board’s Consumer Confidence Index, from 80.2 in September to 71.2 in October. And the ADP monthly employment report showed only 130,000 new jobs were created in the private sector in October, falling short of the consensus forecast of 150,000, while the previous month’s report that 166,000 jobs were created in September was revised down to 145,000. 

Yes, there were also a few positive reports like industrial production in September, and the Chicago PMI index.

But overall, economic reports continue to support Chairman Bernanke’s probable personal bias to delay tapering until next spring if at all possible, to avoid any fallout from Congress’s next go at the spending bill and debt-ceiling debate, and to leave his successor with a clear desk from which to make her own decisions.

As I said in last week’s article, investors probably have reason for caution short-term, due to the market’s short-term overbought condition and the high level of investor bullishness.

But the renewed concerns about Fed tapering soon are probably premature.