By Chris Wrenn Ben Bernanke and the Federal Reserve began easing with the goal of seeing the U.S. through a difficult economic landscape. By lowering rates and inflating its own balance sheet, the Fed has been able to successfully prop up asset prices and push up equity markets to all-time highs across multiple indices (the Bernanke put anyone?). This has left bulls rejoicing and bears mourning.
Although the Fed’s easing programs have assisted in bringing an end to the recession, tepid growth has ensued. While the financial markets surged, the “real” economy sputtered. While the job market and other macro indicators stubbornly trended higher, the recovery has left much to be desired. The easy money was there but a lack of velocity has kept funds from reaching and impacting Main Street. This highlights the difference between the stock market and the actual economy. Whether you’ve been a bull or a bear over the course of this latest bull market, we all knew the inevitable would happen. Eventually, the punch bowl would be removed and we’d have to find a way to come down from one hellacious bender.
Fast forward to June. Big Ben tries floating the idea of pulling back of the rate of asset purchases, just to stick a toe in and test the waters. Mr. Bernanke spoke of the possibility of slowing up if macro economic factors continued showing growth and improvement… I think he likened it to slowing up on the accelerator while not hitting the brakes.
And thus, taper talk was officially born. The market reacted to Mr. Bernanke with a mini-panic. Equities gapped down while the yield on the 10-year quickly moved higher, along with mortgage rates. It seemed as if the market was trying to price in not only a taper but a full-fledged slamming on the brakes, if you will. The Fed quickly responded by taking a dovish tone in order to ease fears of a messy and abrupt end to the easy money policies of late.
I think we can all agree on this broad timeline of events, but the question remains. What now? Will we see tapering in September? December?
Fast forward to today.. Treasury yields are off the highs with the 10-year consolidating around 2.5%. Macro indicators of late have been somewhat shaky. Retail numbers disappointed earlier this week while inflation reports also show surges in energy and food costs. The housing market took a hit in June on the prospects of higher mortgage rates. Building permits for June fell to 911K (vs. 1000K expected). Housing starts also missed with a number of 836K (vs. 958K expected). These numbers are of particular importance with the current uncertainty regarding rates. You would expect the prospect of higher rates to either scare homebuyers into or away from the market so these numbers might be telling. We also got some input from the Fed this week. We got a look at the beige book and also heard Mr. Bernanke’s semiannual monetary policy report to Congress. The beige book reported that the economy grew at a ‘modest to moderate pace’ in June and early July. The Fed pointed to an upbeat housing market with upticks in residential real estate and construction. Consumer spending and auto sales also helped drive growth. In Chairman Bernanke’s report to Congress, he noted the same growth report, even as the economy faced ‘strong headwinds created by federal fiscal policy.’ Regarded future monetary policy, Mr. Bernanke had this to say:
“I emphasize that, because our asset purchases depend on economic and financial developments, they are by no means on a preset course. On the one hand, if economic conditions were to improve faster than expected, and inflation appeared to be rising decisively back toward our objective, the pace of asset purchases could be reduced somewhat more quickly. On the other hand, if the outlook for employment were to become relatively less favorable, if inflation did not appear to be moving back toward 2 percent, or if financial conditions–which have tightened recently–were judged to be insufficiently accommodative to allow us to attain our mandated objectives, the current pace of purchases could be maintained for longer. Indeed, if needed, the Committee would be prepared to employ all of its tools, including an increase in the pace of purchases for a time, to promote a return to maximum employment in a context of price stability.”
Imagine that, the prospect of an INCREASE in the pace of purchase for a time. So now what?
I honestly don’t think a September taper is set in stone. I do believe it hinges on the data we see over the next few weeks. The figures regarding the housing market and employment are key. The Fed and Mr. Bernanke will also need to see how the market digests the prospect of higher mortgage rates. On top of that, the markets are in the middle of earnings season. The economic numbers thus far have been pretty average for this stage of the economic cycle. But, that said, I’m sure the Fed would like to see a strong finish to the season. The GDP number at the end of July will also be important (and there are already whispers of the potential for a negative print). For the record I believe the number will be positive — I see a number around 1% to be fairly likely.
I believe Big Ben when he says this is still a fluid situation. ‘Gun to my head,’ I don’t think we see tapering until December… BUT the next 3 weeks should bring a lot of clarity.
About Chris Wrenn: Chris graduated with a degree in finance from Lenoir-Rhyne University and is currently living and working in Charlotte, North Carolina. He began his career as a financial advisor before transitioning into an analyst role, helping his firm manage money for clients. He focuses on intermediate macro fundamentals across equities, commodities and treasuries. Chris also enjoys investing personal funds and learning swing and positional trading techniques. Apart from following the markets, Chris likes spending time with family and friends, travelling, and following sports of all types.
Twitter: @WCWrenn024 and @seeitmarket
Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.
