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Don’t rule out a surprise December ‘taper’ by the Fed

The facade of the U.S. Federal Reserve building is reflected on wet marble during the early morning hours in Washington, July 31, 2013.

Jonathan Ernst/Reuters

What a difference a month makes.

Deutsche Bank's U.S. economists say this week's meeting of the Federal Reserve's policy committee will be a "non-event," echoing the majority opinion on Wall Street.

Remember September? Wall Street was abuzz at the prospect that the central bank finally was going to curb its monthly bond-buying program and begin the long walk back to a normal policy setting. But policy makers didn't like the look of the clouds that were forming on the horizon. They changed nothing.

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Is the lesson to ignore the Wall Street consensus? Not necessarily. Even those who seek profit by going against the herd think the Fed will stay the course when officials gather for a two-day meeting that ends Wednesday. The latest hiring data is at best mixed, meaning policy makers still lack the clear evidence of a stronger labour market that kept them from tapering in September. Quantitative easing, or QE, will continue unabated.

The consensus view now is that tapering will begin in March. That hard shift does deserve some scrutiny.

Six weeks ago, most market participants were convinced Fed officials were worried that their stimulus measures were creating asset-price bubbles and therefore were intent on ending QE as quickly as possible.

What happened? Mostly, it was the September jobless data, which were released last week after being delayed by the federal government shutdown.

The report showed the trend in the growth of company payrolls decelerated over the summer. Fed Chairman Ben Bernanke has been clear that as long as inflation stays low, the Fed will leave stimulus in place until the labour market improves substantially. That condition still hasn't been met.

But will it now take until March to be met? After missing so badly in September, it's possible that Wall Street now has over-adjusted.

Hedgeye Risk Management, a research firm, questioned last week whether the U.S. labour market really is any weaker now than it was in the summer, when the Fed was sending signals that 'tapering' would begin before the end of 2013. The four-week moving average of initial jobless claims, for example, remains around 350,000, a level that is consistent with stronger jobs growth.

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It's also important to keep in mind the other reasons the Fed gave for holding off on curbing QE in September.

One was the sharp jump in interest rates in anticipation of tapering, which the Fed said threatened to undo much of what the central bank had accomplished in coaxing the economy back to life, especially the resurgent housing market. That climb has since reversed – perhaps too much, Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, said Friday.

"The central bank now has one of the three ingredients that were missing for a September tapering: a calmer bond market," Mr. Shenfeld said in his weekly note for clients, which he used to predict that the Fed will curb its asset purchases in January.

The minutes of the Fed's September policy meeting show that officials also were concerned about the risk of a government shutdown and the unusually public debate over who should replace Mr. Bernanke.

The latter question was resolved when Harvard economist Lawrence Summers bowed out and President Barack Obama officially nominated Janet Yellen, and the former issue also has been resolved, at least for now.

Politicians agreed to extend the government's spending authority into January to allow the Treasury to borrow as much as it needs until early February. It's too soon to know how much the shutdown hurt the economy, another reason the Fed likely will remain in a holding pattern this week. But few think the impact will be lasting. Kevin Logan, chief U.S. economist at HSBC, said in a report last week that he was leaving his 2014 outlook unchanged because real-time consumer sentiment data already was perking up.

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To be sure, Congress has given the public every reason to expect another budget shutdown in January.

But before then, Democratic leaders in the Senate and Republican leaders in the House of Representatives have pledged to agree on a longer-term budget plan by Dec. 13.

An agreement would remove fiscal uncertainty as a risk to the economy just before the Fed's leaders gather for their final policy meeting of the year the following week.

The Wall Street majority might not agree, but a December "taper" remains a distinct possibility.

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About the Author
Senior fellow at the Centre for International Governance Innovation

Kevin Carmichael is a senior fellow at the Centre for International Governance Innovation, based in Mumbai.Previously, he was Report on Business's correspondent in Washington. He has covered finance and economics for a decade, mostly as a reporter with Bloomberg News in Ottawa and Washington. A native of New Brunswick's Upper St. More


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