Fed shackled to stimulus amid US, global economic tapering
If it reduces bond purchases, it'll be a victory of hope over data as signs point to weakness
The main thing tapering these days seems to be the global economy, punching a hole in expectations that the Federal Reserve will soon start to scale back its bond purchases.
San Francisco Federal Reserve president John Williams said on Monday that the US central bank might start to "taper" bond purchases in coming months as part of a slow reeling back of monetary stimulus. Dennis Lockhart, the president of the Atlanta Fed, held it out as a possibility, saying tapering might be considered as a possibility in August or September but stressed that now was not the time.
It may happen, but if it does, it will be a victory of hope over data.
Monday also brought news that orders at US manufacturers were sharply lower last month, with a leading survey reporting its worst showing in four years, results consistent with an actual contraction of industrial output.
Since the Fed must attempt to manage the economy in a global context, it is worth noting that this came just hours after a similar survey in China showed very similar results.
That is even before we consider the tale told by US data late last week, which showed an economy with weak employment and less support from the supposedly hot housing market, not to mention middling overall growth.
Even the Federal Advisory Council, a dozen high-level bankers who advise the Fed, acknowledged that it may be years before quantitative easing can be scaled back.
"Based on economic forecasts, and in light of ongoing economic weakness, continuing fiscal policy restraint, and the recent downturn in inflation, it is likely that current policy accommodation will continue for one to three years," according to minutes from a May 17 council meeting released on Friday.
And this from a group that at the same meeting warned about the potential for inflation and groused about how Fed policy was impairing profitability in its own industry.
We are now about four years into an uneven and unsatisfactory recovery. Historically, economic expansions last about five years, making this economy the kind of insurance risk few would want to underwrite. The Fed is highly unlikely to want to do anything to hasten the normal transition from growth to recession. For it to act, we are going to need to see much better employment data, starting with tomorrow's nonfarm payrolls.
So rather than actually tapering, we can count on the Fed to do what it so clearly wants to do - which is to talk about tapering with an air of confidence. That will help to convince markets not only that removing stimulus is an option but that it is one that is within its power to bring off smoothly.
Some, like chairman Ben Bernanke, may wish to prepare the market for steps he may ultimately take, while getting a chance to gauge investors' reaction.
Some, like Dallas Fed president Richard Fisher, may simply see the costs and risks of bond buying as outweighing the benefits and want to get on with whatever will follow in its wake.
Financial markets seem to view the tapering talk with a mix of reflexive cynicism and gripping horror. Bonds have indeed sold off in the past month, and it is possible to chalk this up to expectations of the slaughter in the bond market that would happen when its main customer provides less support.
Equity investors view good data as bad news, reasoning that it will lead the Fed to withdraw support and undermine demand for stocks, not to mention demand in the economy itself.
That leaves the Fed shackled to a policy of supporting asset markets as a somewhat roundabout way of supporting employment and the overall economy.
That policy may or may not be working to deliver on the Fed's dual goals on employment and inflation, but it is definitely having an impact elsewhere.
By driving up asset prices, the Fed produces stimulus, but it does it by spreading the wealth ever more unequally.
The most telling economic statistic of the week may be from Porsche, which reported its best ever month in North America, with a rise of 38 per cent in sales from a year ago.
What is good for Porsche may or may not be good for America, but the Federal Reserve seems locked into a policy that will be good for expensive sports cars, and their drivers, for some time.
Tom Holland is on holiday