If you’re wondering what might stop the Fed from unveiling a taper over the next six months, the answer is “nothing.”
It’s almost impossible to imagine a macro scenario that pushes an unveil into 2022. Clearly, the combination of August’s lackluster jobs report and a cooler-than-expected read on inflation provide the Committee with more than enough plausible deniability when it comes to punting at the September meeting, but one way or another, the taper debate has a “now or never” feel to it. Either inflation takes off and you’re behind the curve, or it abates materially as the economy cools and then you’re tapering into disinflation.
I’ve long contended that policy normalization isn’t really possible, or at least not if by “normal” you mean a return to pre-financial crisis conditions. As we’ve seen in Japan and, increasingly, in Europe, the situation can become an intractable quagmire (see the figure on the right, below, from BofA).
There will always be an excuse to kick the can and while the pandemic may have changed the game when it comes to some of the myriad structural forces pushing down on inflation, it certainly didn’t eliminate all of them.
The point is simply that if the Fed doesn’t get moving on the taper soon, they may end up faced with the choice of tightening policy into a decelerating economy.
Peak growth is behind the US. That’s not to say the economy can’t sustain momentum or that outcomes won’t be robust, but you’d be naive to think that the odds of an overheat are materially greater than the odds of a disinflationary double-dip. I’d call it a coin toss.
With all of that said, the virus is a wild card. And, indeed, respondents to BofA’s September Fund Manager Survey said the Delta variant would be the most likely reason for a delayed taper (figure on the left, below).
Still, 84% expect a taper unveil by the end year, underscoring everything said above as well as the palpable sense of urgency among many officials.
While there’s doubtlessly a lot of truth to the notion that Fed officials inclined to “get moving” on the taper “sooner rather than later” are concerned about inflation (or, more likely, the perception among the public and lawmakers that the Fed is asleep at the wheel), I’d wager there’s also some worry that if the Fed doesn’t reduce the pace of monthly purchases fairly quickly, the Committee could face a daunting communications challenge in 2022 in the event the world’s largest economy loses momentum.
Recall that just last month, RBNZ was forced to delay a rate hike after Jacinda Ardern instituted a “snap” lockdown. Later, officials made it clear that the delay wasn’t due to any change in the economic outlook, but rather to the impossibility of explaining to the public why the central bank hiked rates on the very same day that the country went into lockdown.
That episode could end up being a microcosm of an eventual Fed dilemma if the taper doesn’t start relatively soon and the virus refuses to leave us all alone. I’ve called this the “Afghanistan” problem — there’s never a “good” time to tighten. Full normalization would probably lead to chaos.
Incidentally, one widely-followed “Finance Twitter” account last month suggested that tapering monthly bond-buying isn’t tightening. That was retweeted by several other popular personalities. Eventually, it landed in a recommended tweets email which elbowed its way into my regular inbox, even as I could swear I unsubscribed from Twitter email notifications. I’m not sure what kind of semantics or logic that person was using, but don’t be deluded. Of course tapering is tightening. Think about it this way: It’s not easing, is it?
Consider the figures (below) from SocGen’s Solomon Tadesse. The shadow rate has fallen nearly 800bps this cycle, with the majority of the easing impulse coming from QE.
“In the last two cycles, unconventional policies in the form of QE have contributed a large part of monetary easing,” Tadesse wrote, in a note out earlier this month. He added that,
In the post-GFC cycle of monetary easing, after three rounds of QE, forward guidance and other unconventional policies, the cumulative short rate fell by 850bps over an extended period of six years, bottoming out in November 2013. In the process, the QE measures accounted for about 62% of the total monetary easing during the cycle. Out of the total monetary easing provided in the ongoing post-pandemic monetary cycle (790bps), by our estimates, more than 65% could be attributed to the series of large-scale QE measures implemented in 2020.
It’s notoriously difficult to pin down a definitive, mathematical relationship between QE and equity prices. That’s more of a “me or your lyin’ eyes” exercise. But there’s academic literature on the shadow rate and the monetary policy stance. Indeed, as Tadesse noted, there are several versions of “empirical implementations.”
If that’s too academic for you (i.e., if you like anecdotes), just note that in this month’s BofA poll, 59% said monetary policy was “too simulative.” That, the bank’s Hartnett observed, was the most since May of 2011.
Little wonder folks are still overweight stocks.