Let's Talk Taper

Marc Fovinci:, Ferguson/Wellmanby Marc Fovinci, CFAPrincipal

 “Ho-Hum” Employment

 All eyes were on the employment report this morning. This morning’s report is the last employment report before the next Federal Reserve meeting on September 17 and 18, and of all the economic statistics, the Fed leans most heavily on the employment report to gauge how well the economy is doing.

Today’s report showed that nonfarm payrolls increased by 169,000 in August and the unemployment rate dropped from 7.4 to 7.3 percent. Although a solid report, it only keeps pace with current “ho-hum” trends. The payrolls report underachieved what the market expected, but the unemployment rate was better than expected. Unfortunately, the good news of unemployment rate was clouded by a lower rate of workforce participation.

The “ho-hum” report does not remove the uncertainty over what the Fed will do at its meeting this month. The report was not conclusively strong enough to make a tapering of Fed stimulus a foregone conclusion. If we were a fly on the meeting room wall, we would certainly expect to witness a vigorous debate over whether to taper or not.

Currently, the Fed is adding $85 billion into the financial system each month through the purchase of securities. In June, Federal Reserve Chairman Ben Bernanke laid out a timetable for reducing the rate of these purchases, leading the market to expect the reductions to start after this September meeting. While a reduction in the size of the purchases is not a tightening of monetary policy, it is a reduction in the rate of stimulus and a new direction for the Fed.

We, along with many investors, expect a “taper-lite” to be announced. A light tapering would be a reduction in monthly purchases by $10 billion, moving from $85 billion to $75 billion per month. With Bernanke’s June timetable and the economy continuing on its trend, it seems appropriate to reduce stimulus by a relatively minor amount.

The markets seem to have already moved in anticipation of a “taper-lite,” so we would expect fairly limited market movement on the announcement: stocks have little reaction and bonds experience a minor sell-off.

The Fed Speaks

On Wednesday, three members of the Ferguson Wellman investment team had the opportunity to hear John Williams, president and chief executive officer of the Federal Reserve Bank of San Francisco, speak in Portland. Fed governor speeches tend to be well-scripted and are usually intended to clarify and explain current Fed policy, not to break new ground on policy and trends. Here are a few of President Williams’ major points regarding the Fed:

  • They consider “forward guidance” a very important policy tool. “Forward guidance” is communication of what the Fed thinks policy is likely to be in the future
  • They expect to keep the federal funds rate near zero until (1) unemployment drops to 6.5 percent or below, (2) they forecast near-term inflation to 2.5 percent or above, or (3) investor inflation expectations move measurably higher. His expectation was that the Fed would maintain its zero percent interest rate policy into 2015
  • They expect to halt their monthly purchases (complete tapering) sometime in the middle half of next year, when they expect the unemployment rate to be about seven percent
  • Tapering is not tightening. It is still adding stimulus but at a slower rate
  • He emphasized on multiple occasions that Fed actions are very dependent on how well the economy performs in the future. All actions are data dependent

Our Takeaways from the Week

  • The economy continues to deliver “ho-hum” performance
  • Expect the Fed to announce a “taper-lite” on September 18, reducing monthly purchases by $10 billion
  • Having largely discounted the event, markets should not have a large reaction to this announcement