by Dan Burrows | June 26, 2013 12:56 pm
The market’s major anxiety for the second half of the year will be the same one that has it freaking out now: When is the Federal Reserve taking away the punch bowl? And can stocks party on without it?
Every major asset class has been whipsawed by volatility ever since Fed Chairman Ben Bernanke said the central bank could start pulling back on its bond-buying program (also known as quantitative easing) sooner rather than later.
The Fed is buying $85 billion in longer-dated Treasuries and mortgage-backed securities every month to tamp down interest rates and encourage spending on everything from homes to cars to capital goods.
The fear is what happens to asset prices and the economy without it?
The market’s bracing for Bernanke to start pulling out of QE as early as the fall, but as the Fed chief said himself, any kind of monetary tightening depends on whether the economy can take it.
Here are five economic reports the normally dovish Federal Reserve will be watching like a hawk for clues as to whether it’s safe to start tapering its bond-buying program:
Bernanke said that subsequent data have to remain broadly aligned with the Fed’s current expectations for the economy in order to reduce the pace of long-term debt purchases, and there’s no more important broad measure of the economy than gross domestic product.
The Fed forecasts GDP to expand between 2.3% and 2.6% this year. But on Wednesday we learned that first-quarter growth was much weaker than initially thought. The Commerce Department said GDP grew just 1.8% in the January-to-March period, well below the prior estimate of 2.4%.
A second-half acceleration in GDP will be critical to the Fed’s plans. After the lousy first-quarter showing, the economy has a lot of catching up to do in the remaining three quarters of the year.
As mind-bogglingly difficult as it is to be a central banker, the Fed’s job description is actually remarkably simple. It has what’s called a dual mandate: Stable prices and full employment. That’s it.
What that normally means is the Fed is supposed to keep inflation in check (usually defined as the historical rate of about 3%) and the unemployment rate at about 5%.
But these are not normal times. Bernanke said that QE would likely come to an end when the unemployment rate is “in the vicinity” of 7%. It’s at 7.6% now — or in the vicinity of being in the vicinity — so expect markets to be especially volatile when the jobs numbers come out at the beginning of every month.
Except for perhaps debtors, most everyone instinctively hates inflation. But deflation is actually much, much worse, because when prices are falling, people don’t borrow and they don’t spend. Why pay for something today when you can get it cheaper tomorrow?
The Fed’s preferred measure of inflation is personal consumption expenditures, excluding volatile food and energy prices (this is known as core PCE) — and that number happens to be dangerously close to deflationary territory.
The Fed is targeting inflation of around 2%, but the April reading on core PCE came in at just 1.05% — the lowest level on record. The Fed clearly expects inflation to pick up, but core PCE needs to get up off the mat if Bernanke hopes to taper anytime soon.
Bernanke made it clear that GDP, unemployment and inflation are the Big Three numbers he’s watching when it comes to whether it will step off the bond-buying gas, but consumer spending is something the central bank — and the market — will no doubt be keeping tabs on too.
That’s because we’ve got a consumption-driven economy, with consumer spending accounting for about 70% of all economic activity. True, a big chunk of that comes from healthcare and other less-than-discretionary spending, but a good 35% still comes from retail sales alone.
Higher home prices, a thawing job market and debt reduction helped consumer spending pick up in the first few months of 2013, but then it went negative for the first time in almost a year. The Fed will be watching this end-of-the-month report to see if the economy is ready to stand on its own two feet.
True, ours is a consumption-driven economy comprised almost entirely of services industries — manufacturing contributes only about 12% of U.S. GDP.
But manufacturing is considered to be the canary in the economic coal mine, because slowdowns and recessions tend to show up there first. That means various readings on activities and orders can offer insight into the economy on a directional basis.
The Institute for Supply Management surveys more than 300 manufacturers every month on conditions ranging from employment to new orders to inventories. Readings above 50 indicate expansion — and give hope that the economy will follow. With the latest reading at 49 — indicating contraction — a pick up is likely in order to for the Fed to feel comfortable about tapering.
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