On Wednesday, the Federal Reserve will conclude its two-day Federal Open Market Committee (FOMC) meeting. And at 2:00 p.m. ET, it will publish its statement, which will conclude update information on the Fed’s plans for monetary policy.
Everyone expects the Fed to keep its benchmark interest rate unchanged at near-0% (officially 0 to 0.25%)
But more importantly, most economists expect the Fed to finally announce that it is tapering its large-scale asset purchase program, which is informally known as quantitative easing (QE).
QE consists of the monthly purchase of $45 billion worth of Treasury bonds and $40 billion worth of mortgage bonds (MBS). All of this has been intended to keep interest rates low to stimulate the economy.
And most economists expect the Fed to begin tapering it.
First, Remember What The Fed Said
Federal Reserve Chairman Ben Bernanke began talking about tapering QE in late May. But the markets didn’t really take him seriously until the June 19 FOMC press conference, which is when he presented a hypothetical roadmap for tapering QE to zero. From the transcript:
…Going forward, the economic outcomes that the Committee sees as most likely involve continuing gains in labor markets, supported by moderate growth that picks up over the next several quarters as the near-term restraint from fiscal policy and other headwinds diminishes. We also see inflation moving back toward our 2 percent objective over time. If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year; and if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear. In this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7 percent, with solid economic growth supporting further job gains, a substantial improvement from the 8.1 percent unemployment rate that prevailed when the Committee announced this program.
Most economists agree that we are on this track.
What Will The Taper Look Like
Ever since the Fed began signalling the taper could come in the Fall, economists have generally estimated that the size of the initial taper would be around $15 billion (i.e. reducing Treasury purchases by $10 billion and mortgage purchases by $5 billion).
However, with economic data falling short of expectations in recent weeks, many economists have reduced their initial taper estimates to between $5 billion and $10 billion total. (This is why we’ve been hearing a lot about “taper-light,” “token taper,” and “soft taper.”)
Here’s a round-up of some taper expectations from Wall Street’s top economists:
- Jan Hatzius, Goldman Sachs (GS): $10 billion all in Treasuries
- Vincent Reinhart, Morgan Stanley (MS): $10 billion all in Treasuries
- Aneta Markowska, Societe Generale (SCGLY): $10 billion all in Treasuries
- Drew Matus, UBS (UBS): $7 billion in Treasuries, $3 billion in MBS
- Michael Feroli, JP Morgan (JPM): $10 billion in Treasuries, $5 billion in MBS
- Neal Soss, Credit Suisse (CS): $10 billion in Treasuries, $10 billion in MBS
- Michael Hanson, BAML: $10-$15 billion total, split evenly between Treasuries and MBS
- Michael Gapen, Barclays (BCS): $15 billion total, split between Treasuries and MBS
“Regarding the composition of the taper, we assume that the Fed will taper both Treasury and agency MBS purchases,” said Gapen. “Many on the committee believe MBS purchases are more beneficial than Treasury purchases, and a paper delivered at the 2013 Economic Symposium at Jackson Hole, WY, also reflects this view.”
Why They MUST Taper Now
Most economists don’t feel 100% confident that the economic data alone is robust enough to justify tapering QE already. Some have explicitly pointed to non-economic reasons why the Fed will taper.
One such reason is because volatility in the markets, the economy, and especially Washington D.C. is currently low and is likely to rise in coming weeks. Here’s Credit Suisse’s Soss:
…The reason is the calendar. If FOMC policymakers don’t begin tapering this month, the next opportunities are their October 29-30 and December 17-18 FOMC meetings.
October is likely to be right in the middle of the debt ceiling fight. In general, people think these fights will end without tearing the fabric apart, but then again, nearly everyone expects a heightened degree of contention and disharmony. Also, President Obama may announce a nominee for Bernanke’s successor in mid-to-late October. This would not be an ideal moment for the central bank to experiment with a potentially disruptive operational change.
The next opportunity after that is the December FOMC meeting. With only minor exceptions, Ben Bernanke has been on a one-way easing street for over six years, beginning back in the summer of 2007. Does he really want his last holiday present to the nation and world economies to be a potentially negative shock?
Still, not everyone agrees we’ll hear about the taper on Wednesday.