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At Jackson Hole, answers on ‘tapering’ remain elusive

When central bankers and leading economists got together last week for their annual monetary gabfest in Jackson Hole, Wyo., a single unanswered question that has roiled the markets for weeks hung over the wonkish proceedings: When will the U.S. Federal Reserve start rolling back its massive bond purchases? The answer remains as elusive as the western state's rare black-footed ferret.

Fed chairman Ben Bernanke, who has often used the gorgeous setting to outline his views on future policy, was conspicuous by his absence. Maybe he was too busy packing for his expected return to academia early next year. But there was no shortage of experts, including a trio of regional Fed bank presidents, willing to wade into the fray.

The central bank could take "a cautious first step" down the taper trail as early as its September meeting, but only if the data justify such a move, Dennis Lockhart, the moderate head of the Atlanta Fed, told Bloomberg. St. Louis Fed boss James Bullard sees no need to rush into tapering the Fed's monthly purchases of $85-billion (U.S.) worth of long-term Treasury bonds and mortgage-backed securities. "I think we can afford to be very deliberate in our decision-making here."

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John Williams of the San Francisco Fed was similarly circumspect, telling CNBC that the reduction in monetary stimulus could begin later this year, but "would be in gradual steps over time ... assuming our [economic] forecast comes true."

The debate over whether and when to cut back is driving investors nuts. They have veered between a mild case of jitters and outright panic ever since monetary officials began signalling earlier this year that they were looking at an eventual scaling back of the unprecedented bond purchases. Their anxiety is understandable. One industry estimate, cited by Barron's, calculates that the value of U.S. stocks has climbed $2.9-trillion since Bernanke and company set off on their third round of quantitative easing last September.

Some Fed watchers argue that the public musing – and the confusing signals from various officials, including Mr. Bernanke – has done more harm than any change in policy. Since the taper talk intensified in recent weeks, 10-year U.S. Treasury yields have climbed to a two-year high, U.S. mortgage rates have shot up, the greenback has soared against most other currencies and billions of dollars have fled emerging markets. All of this is occurring against a backdrop of a slowing global economy.

No wonder IMF chief Christine Lagarde warned the Jackson Hole crowd that monetary policy "should remain highly accommodative, as the risk of recession outweighs the risk of inflation." Policy makers, she said, "should stand ready, as needed, to dive back into unconventional waters."

But studies have shown that the Fed's foray into such unconventional measures has been far better for the markets than the actual economy, where it has had a minimal effect on growth. It's long past time, critics argue, to get back to something resembling normal monetary policy.

"All that really happened in the U.S. is that quantitative easing artificially depressed rates," says Wes Mills, chief investment officer with Scotia Asset Management. "So this [rebound in long-term rates] is actually a good thing, because central banks and monetary policy shouldn't be overly intrusive in the market. We know why Bernanke did it. He needed to have the wealth effect to get the housing market back on its feet and he's effectively done that."

In any case, the central bank is not expected to do anything more drastic than trim its monthly purchases of Treasuries and mortgage securities by at most $10-billion to $15-billion. Which hardly constitutes a dramatic reduction in monetary easing. And no one is talking about actually raising rock-bottom interest rates before 2015 at the earliest.

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People are preoccupied with tapering, because they equate it with tighter monetary policy, Mr. Mills says. "But it's not. It's rate of change. If you go from buying $85-billion [worth of securities a month] to $75-billion, you're still adding stimulus."

Yet even though there is no hint of a Fed rate hike on the horizon, the market reaction has resulted in a steepening yield curve. "You're just getting the long end back to a more normalized level," Mr. Mills says. "That's a good thing."

Fed policy makers may hold off on any tapering this year if they don't see enough improvement in the employment outlook. Also, Mr. Bernanke's second and final term is set to expire, and they may not want to tie his successor's hands. But his replacement – the leading candidates remain former treasury secretary Larry Summers and the more dovish Fed vice-chair Janet Yellen – is unlikely to change the playbook much.

"You can't have a central bank intervening in markets perpetually," Mr. Mills says. "You can't have QE infinity, because at some point, you bloat the central bank's balance sheet to the point where you lose confidence in the currency and the management of the over-all economy."

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More


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