Fed Tapering: What Does It Mean?
(Peter Tran, 7/9/2013)
What is Tapering? Does Tapering really mean monetary policy tightening?
The central bank’s task is a juggling act to balance out different policy objectives. The main policy objectives are: (a) price stability [inflation], (b) stable currency, (c) controlling asset price inflation / deflation [a well functioning banking system], and (d) full employment.
Before dealing with the Tapering issue, let’s examine the nature of the QE programs.
- Stated purpose. The Fed wants to promote a sustained economic growth recovery.
- Unstated purpose. In response to the deleveraging forces from the financial sector, shadow banking, household sector, foreign CB selling Treasury and agency debt, negative marginal productivity of debt, and declining money velocity, financing U.S. budget deficit, the Fed has to implement the QE programs to counteract.
In terms of inflation, the official CPI and inflation expectations remain low. The Fed does not seem to worry much about this policy variable. Next, the U.S. dollar is currently the King of currency. The dollar has been strengthened, while the US economy has been weakened. I don’t think the Fed has any interest in tightening its policy to see the dollar strengthen further. In terms of full employment, the Fed had explicitly anchored its monetary policy to an unemployment rate of 6.5%. It means that it won’t be tightening its policy any time soon. In the meantime, the global economic backdrop is not very bright. European economies are lingering in recessions. China is busy fighting with its credit demon. Many PMI indices in EM countries are flirting with contraction. The US economy has slowed down to a stalled mode. Lastly, the divergence between asset price inflation and economic reality is deafened. Prior to the June official FOMC Tapering meeting, the Fed has repeatedly and openly expressed its concern about asset price inflation. In this particular phase of an investment cycle, the Fed typically begins its monetary tightening by raising the interest rate to cool down the speculative asset price inflation. However, in this current cycle, the Fed’s hands are tied. It needs to induce the market to do the monetary work through the utilization of its communication tool.
After analyzing all the monetary policy variables, we can logically conclude that the Tapering talk was a monetary communication tool to jawbone the market to influence ST policy objectives.
- Cooling down asset price inflation.
- Driving down precious metal (PM) prices to help gold bullion banks to adjust their PM portfolio positions [especially given an unsustainable and ongoing imbalance between demand and supply in the physical PM markets].
- Creating some operating room for the next coming Fed chairman in 2014.
- If the conditions (less deficit financing, foreign selling, etc.) are improved, the Tapering (buying less) can occur. However, Tapering does not construe monetary tightening.