By Colin Cieszynski, Senior Market Analyst, CMC Markets
Following the decision to commence tapering at the last meeting, this article looks what the possible outcomes from the forthcoming FOMC meeting could mean for market participants this year.
The article addresses:
- The key questions following the Fed meeting in December
- Why QE may be trimmed by $5 billion rather than $10 billion
- What a QE3 tapering programme over the course of 2014 could look like
- Whether the tapering programme will likely change as Dr. Yellen take the helm
After the Fed started tapering at last month’s meeting, some traders may have been asking what the FOMC could do for an encore. In some ways though, this month’s meeting has the potential to be even more critical for setting the trend of monetary policy going forward.
Continued tapering and a wrap up of QE3 by the end of the year appears to be on the way based on comments following the December meeting. The key question on everyone’s minds moving into 2014 is whether the Fed will taper consistently and predictably, or whether it will stop and start tapering which could create more uncertainty.
A secondary question that will likely play out over the next two or three meetings is what the change in leadership, rotation of regional Fed voters and comings and goings among permanent FOMC members will mean for the trend of monetary policy in the months and years to come.
The Fed tends to act methodically and consistently
Being the central bank of the world’s reserve currency carries a lot of responsibility. While not everyone may agree with what the Fed is doing, once it sets out on a course, it has tended to stick to it. Here are three examples from this century so far
Between January of 2001 and June of 2003, the Fed cut interest rates 13 times, lowering the Fed Funds rate from 6.50% to 1.00%
Between June of 2004 and June of 2006, the Fed raised interest rates 17 times, increasing the Fed Funds rate from 1.00% to 5.25%
Between September of 2007 and May of 2009, the fed cut interest rates 10 times, lowering the Fed Funds rate from 5.25% to 0.25% where it has remained since.
Having started tapering in December, further cutbacks to QE3 purchases appear likely throughout this year. In fact, following the disappointing nonfarm payrolls report, a number of FOMC members suggested that they thought the data was distorted or a one-time anomaly and that one poor result would not stop the tapering program.
A potential tapering program that winds up QE3 over the course of the year could look something like this:
|Possible Fed tapering schedule|
December 18, 2013
January 25, 2014
March 13, 2014
April 25, 2014
June 20, 2014
August 1, 2014
September 13, 2014
October 24, 2014
December 12, 2014
Source: CMC Markets, www.federalreserve.gov
Through the rest of this preview, I am going to consider the above scheduled as the base case for a tapering program with any moves to accelerate tapering seen as more hawkish and any moves to delay or slow the pace of tapering as being more dovish.
2014 to be a year of change at the Fed
There are a number of changes underway at the Fed that could impact how members vote through the year and potentially could impact when the Fed turns from tapering QE to normalizing interest rates (likely in 2015).
The first big change comes at the top but with Dr. Yellen moving up to the big chair from second in command, the focus appears to be on continuity over revolution. Moving down the ranks there are a number of moving pieces that could influence direction moving forward.
This meeting brings the usual rotation of regional governors into the voting booth. This year, a more hawkish group is coming in who may keep the tapering program on track and could try to accelerate things. In addition,
In addition over the next several months, two permanent voting members and one voting regional President will be leaving the Fed shortly, so there will be three additional new voters who could potentially change the mix as the year progresses.
At the last FOMC meeting, all members voted to start tapering except for Boston Fed President Rosengren who wanted to delay tapering. In recent years, the main dissenters have been those who wanted to end QE sooner, this year, the dissenters may by those who want to delay tapering.
Factors that may affect this month’s tapering decision
This is Chairman Bernanke’s last meeting at the helm but it’s unlikely that the tapering process will change very much on the transition to Dr. Yellen. As the current Vice-Chair and on her way to confirmation at the time of the last meeting, she would have played a significant role in the decision to start tapering already. In addition, support at her confirmation vote was weak due to her dovish reputation suggesting that a U-turn on tapering could face political opposition.
The December 2013 nonfarm payrolls was a big disappointment but the ADP payrolls report was not. Weak nonfarm could also be blamed on the bad weather across much of North America in December, so this likely won’t be a factor in the decision.
One external factor that could play a role though is the debt ceiling negotiations. Although the spending deal recently sailed through Congress and Republicans still appear to be smarting from the reputational hit they took back in October, there is still a small risk that some elements could try to cause an issue over the February/March debt ceiling deadline ahead of the mid-term election primaries.
Because of this small political risk, the Fed may decide to trim QE by $5 billion instead of $10 billion this time around. The debt ceiling deadline is February 7th with the Treasury able to use emergency measures to keep payments going for about a month
Recent comments from FOMC members and voting outlook
To get a better sense of when the Fed may start tapering, we reviewed recent public comments from FOMC members since the last meeting to get a sense of where each of them stands on the issue of tapering.
We have divided members into four categories
H Hawkish likely to vote to continue or accelerate tapering
C Continue likely to vote for a $5-10 billion taper and keep the program going
L Leaving preparing to exit Fed soon, likely to vote for $5-10 billion taper
D Dovish likely to vote to pause tapering for now and resume later
I have assumed that those members who voted to taper in December and quiet since then have not changed their minds.
L Ben Bernanke (Chair)
C Janet Yellen (Vice-Chair)
C William Dudley
C Jerome Powell
L Sarah Bloom Raskin
C Jeremy Stein
C Daniel Tarullo
H Richard Fisher (Dallas)
D Narayana Kocherlakota (Minneapolis) Fed needs to do more to stimulate economy
L Sandra Pianalto (Cleveland)
H Charles Plosser (Philadelphia)
H Jeffrey Lacker (Richmond 2015 voter) Expects another $10 billion taper this month, one poor job report not enough reason to stop
H Dennis Lockhart (Atlanta 2015 voter) supports tapering and thinks Fed should clarify when it plans to start raising interest rates
D John C Williams (San Fran 2015 voter) accommodative policy will continue for quite some time
D Charles Evans (Chicago 2015 voter) low inflation worrisome
H James Bullard (St. Louis)
H Esther George (Kansas City)
D Eric Rosengren (Boston)
Incoming Fed Members
Stanley Fischer (Vice-Chair nominee) Former Governor of Bank of Israel, taught economics to Fed Chair Bernanke and ECB President Draghi. Essentially replaces Dr. Bernanke. Very experienced at international level.
New Cleveland Fed President
2014 FOMC Voters – 5 Continue, 3 Leaving, 2 Hawkish, 1 Dovish
2013 Non-Voters – 4 Hawkish, 2 Dovish
This tally suggests a clear majority of FOMC members would likely vote to continue tapering through a cut of $5-10 billion per month of QE purchases. A sizeable group could agitate to accelerate tapering as the year progresses but may not get much traction yet. Doves could have a tough time mustering support.
If tapering is continued or accelerated, the most likely dissenter appears to be Minneapolis Fed President Kocherlakota. On the other hand a dovish shift to pause tapering would likely be met with dissent from Dallas Fed President Fisher and Philadelphia Fed President Plosser.
What could the tapering decision mean for trading?
The Fed’s QE3 program has propelled stocks dramatically higher over the last year, but as tapering winds down the big inflows of Fed money into the system, there is a risk stocks could fall back under their own weight. Don’t forget that after the end of both QE1 and QE2, major world indices fell by over 10% within three months. Offsetting this is potential support from an improving underlying economy.
With US indices trading at or near all-time highs in January, it appears while the street has recognized the potential for tapering this year, it has not really affected stocks in a meaningful way yet. That being said, the Generals in the Dow and S&P have shown signs of shifting from accumulation to distribution which could accelerate on a decision to continue or accelerate tapering.
The USD, on the other hand, has been climbing since May on anticipation of tapering and may continue to recover at a moderate pace. There has been some strength in gold and silver, which took the brunt of tapering related selling last year and may be staging a relief rebound from depressed levels.
Major paper currencies, on the other hand, may continue to weaken as USD recovers including EUR, AUD CHF and CAD. GBP and NZD may attract relative support with their central banks also leaning toward tighter monetary policy.
A decision to pause tapering could have a larger impact on USD as that could undermine the gains of recent months.