Unemployment down. Economy on stronger footing. Reduced fiscal uncertainty out of Washington.
Three major stated criteria for tapering quantitative easing (QE) the Fed included in its forward guidance—and three things making headlines of sorts this week. So is that it? The trigger for tapering? Wider yield spread soon to come, combined with more profitable and hence, plentiful, lending? If that’s what you’re thinking, we’d suggest slowing down a tad. Fed forward guidance used to have another name—jawboning. For the record, forward guidance is no more set in stone than jawboning, it just has a more formal-sounding name. This is why attempting to predict QE’s end is folly. But, whether QE ends today, next week or six months from now, the US economy is still in good shape and will likely accelerate even more once the Fed takes action.
Already this month a bevy of data have illustrated continued US economic growth. November’s employment situation report added yet another point. Total nonfarm payroll employment increased by 203,000, and the unemployment rate dropped from 7.3% to 7.0%. The unemployment report often amounts to the mother lode for data miners, but even they struggled to find material negativity in November’s data. Total nonfarm payroll employment has increased at a fairly steady rate over the past several months. Even this month’s civilian labor force rose by 445,000, though some still groused that the rise didn’t offset last month’s 720,000 drop. But this is a nonsensical caveat, in our view—both figures appear skewed by the government shutdown, making comparisons between the two pretty wonky. The longer-term trend is more telling, and this shows an overall rise in the labor force since 2010. Moreover, this is the second consecutive month of strong hiring, as per the establishment survey—which wasn’t much muddied by the shutdown—hence why some think the economy has met one of the Fed’s proposed taper-on criteria.
Fed head Ben Bernanke has often also wagged a finger at Congress, suggesting his supposedly stimulative policy was necessary to offset drag caused by gridlock, the sequestration and budget squabbling. Friday, news broke that budget talks may actually be progressing*. And before the last possible second, no less! (Don’t worry, they still have time to backslide.) Sen. Patty Murray (D-WA) and Rep. Paul Ryan (R-WI) are trying to nail down a two-year deal, which would give us all a brief break from annual budget bickering and remove the threat of a January government shutdown. Our bipartisan gang of two also plans to water down the sequester a bit, bumping discretionary spending to roughly $1.015 trillion in 2014 and 2015 by cutting some federal pensions and raising air travel security fees, among other shifts. Overall, it isn’t the most revolutionary fiscal policy ever (grand bargain, we barely knew ye), but by easing the sequester’s so-called cuts and zapping budget uncertainty for two years, it would seem to resolve that “fiscal policy is restraining economic growth” tidbit that keeps surfacing in Fed press releases.
Considering the Fed has on several occasions hinted it’s taper time once unemployment hits 7.0% and fiscal uncertainty fades, many expect bond purchases to slow soon. But targets and conditions are only useful if you take the Fed at its word—forward guidance isn’t ironclad. For instance, Ben Bernanke told Congress in May tapering could start as early as September if economic conditions improved. September rolled around, the FOMC noted economic and labor market improvement since QE began last year, but QE continued. The Fed wanted further evidence the improvement was sustainable. October rolled around and the Fed played the same game. Eight days before the Fed’s December meeting, the game is beginning anew. In a Monday speech, St. Louis Fed President James Bullard hinted at a “small taper.” Richmond Fed President (and longtime QE opponent) Jeffrey Lacker said he expects a taper debate. But last Friday, Chicago Fed President Charles Evans said he’d need “a couple months of good numbers” before voting for a taper. In other words, not all FOMC members see this the same. The Fed isn’t a unified body, and when you have 12 people with different views and beliefs voting on policy, policy won’t always (or, dare we say, often) match guidance. This is why the timing of Fed policy moves is near-impossible to handicap.
More important than the “when” of tapering, however, is the “what happens.” Once the Fed stops buying $85 billion in long-term bonds per month, long-term interest rates should have more freedom to rise, which should widen the yield curve spread. A bigger gap between short and long rates should encourage banks to lend more eagerly, removing one of the primary headwinds to growth during this expansion.
However, the US economy likely doesn’t depend on QE’s end for continued growth—US businesses have already proven they can grow amid the anemic money supply growth, and the latest PMI and LEI figures suggest this isn’t about to change. Firms are remarkably good at adapting to the current environment—and, importantly for stocks, finding ways to profit. With earnings and revenues still growing despite the Fed—and reality overall better than most perceive—stocks seem set to rise even if QE lasts a while longer.
*Progress here is defined as members of Congress not currently being at each other’s throats. Which could easily change on a dime.