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Weekly Economic Commentary

 
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The tale of the tapering

June 14, 2013

View PDF version

For 13 days of every fortnight, my kids think that "floor" and "hamper" are synonyms. Stray shoes litter the entryway, used cups adorn the coffee table and spent contact lens packaging forms a grand pyramid on the bathroom vanity.

Then the winds of change blow through the house, for on the 14th day, the cleaning crew arrives. The night before, my wife offers direction and guidance to the children in the hope of promoting an orderly adjustment. More often than not, though, it only produces volatility: clothes, cups and children fly about wildly, hopefully ending up in the right place.

Such has been the case recently with the Federal Reserve’s attempt to foreshadow possible reductions in monthly asset purchases. While the Fed is hoping for an orderly adjustment, markets have been confused by the guidance they’ve received over the past few weeks. Daily trading ranges in the bond market have been very wide, and overall market volatility has risen sharply.



Part of the problem may lie in the Fed’s choice of words, but a lack of complete clarity around the direction of the American economy muddies the waters for everyone. The future of quantitative easing (QE) has been a frequent topic of conversation with partners and clients globally, so we thought we’d devote extra space to the issue this week.

The Federal Open Market Committee (FOMC) will convene next week to refresh its understandings and review its policy. A statement summarizing the group’s forecasts and views will be released next Wednesday, and Chairman Bernanke will conduct a press briefing immediately afterward. Following is a matrix analysis of what factors will bear on the decision and how they might support stasis or change.



 

 

 



We do not expect any change in the QE program to emerge from next week’s meeting. But the statement that follows it - and the Chairman’s subsequent discussion with the press  must focus on reducing the range of uncertainty so markets work with the Fed, not against it.

Everything remains dependent on incoming economic data. Questioners will certainly press for more specific dates or decision rules, but Chairman Bernanke will not be in a position to offer them. Our sense, though, is that the Fed has not been happy with the disorderly rise in rates, and will design communication to bring them back into some reasonable range.

There is a diversity of opinion within the FOMC. Philosophies and forecasts differ, and this will be evident in the dispersion of projections that will be shared next Wednesday. Nonetheless, there has been little formal dissent over recent decisions, and markets might focus a bit more on the consensus that Bernanke has been able to maintain. The Fed is not a house divided.

The Fed’s message must stress that a reduction in the pace of asset purchases, when the time comes, is not a tightening of policy. It merely means that it will not be adding to accommodation at the same pace. Further, the first step does not guarantee that the second step will follow close behind, or that outright asset sales are anywhere on the horizon.

My wife is forever trying to find the right message to get our kids to work with her, not against her. I hope she finds the best phrasing soon; any reduction in the cleaning crew chaos would be a very welcome thing.

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The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.
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