Fed Tapering: Expect Monthly Asset Purchases Reduced By $10B

One week after a mixed US jobs report and 5 days before the FOMC decision, we stick with our expectations for the Fed will taper monthly asset purchases by $10 bn, all from US treasuries, rather than mortgage-backed securities.

Last week’s US jobs report may have disappointed on the NFP, downward revisions and lower participation rate but offered fresh 5-year lows in the unemployment rate at 7.3%. Yesterday’s release of weekly jobless claims saw a 7-year low at 292K but the figure omitted data from two states due to faulty computer systems. But the declining trend remains firmly in place, a much needed development to counter the falling labour participation rate.

Today’s preliminary reading of the September University of Michigan consumer sentiment survey showed a 6-point decline to 76.8, the lowest level since April and the biggest monthly fall of the year. The decline was attributed to the expectations component as well as the disappointing July and August NFP figures of 104K and 169K respectively.

But it remains that US labor markets and the economy as a whole have shown notable improvement since the Fed started purchasing $85 bn in treasuries and MBS each month since January.

Considering that next week’s FOMC meeting coincides with a scheduled post-meeting press conference, the safer path is for Ben Bernanke to announce and implement a modest tapering, especially as the unemployment rate is nearing the 7% figure deemed appropriate by the Fed Chairman for terminating asset purchases. In the words of Chairman Bernanke in June: “We look at participation, payrolls, a variety of other data. But the 7% unemployment rate is indicative of the kind of progress we’d like to make in order to say we’ve reached substantial progress.”

It’s all in the Presentation
Thanks to the magic of forward guidance and semantics, the FOMC may well announce a tapering of asset purchases without risking a rapid rise in bond yields or a sharp rally in the US dollar. This can be done via issuing neutral to lower central tendency forecasts e.g.

conservative upgrade of 2014 and 2015 GDP growth, weaker inflation and mixed forecasts view on unemployment. Most importantly, Chairman Bernanke can re-emphasize the dovish notion that 7% is a threshold and not an automatic target for terminating all asset purchases. He could also add that terminating asset purchases will not immediately be followed by a hike in the Fed funds rate, which would cement expectations that rates to remain on hold for at least 2 years. Finally, the talk about inflation always does the trick for the dovish camp as the Fed reiterates its concern with an excessively low inflation rate.

And finally, optimism from delaying a strike on Syria can absorb any negatives from a tapering announcement- a preferable solution to coinciding the tapering with action in the Middle East.

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