Monday, December 9, 2013

To Taper or Not to Taper

I think it's time for an ACH (click for an introduction to ACH) on the much discussed tapering issue, more so, as it looks likely to be announced at the December 17-18 meeting (by tapering I also mean the communication that precedes the actual slowdown in QE).

So the hypotheses are:

H1 - the Fed will taper at the December meeting;
H2 - the Fed will not taper at the December meeting.

Here is a matrix with a score measuringmy judgement on how much each piece of evidence invalidates each hypothesis.


                             Evidence                                                       H1                     H2
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E1 - the economic indicators have been strong lately
and the Fed wanted to start tapering in September                       +                      -0.75

E2 - the latest GDP report has been strong but only
due to rising inventory                                                                -0.25                    +

E3 - the Fed has not started to communicate its
possible tapering intentions yet                                                   -0.75                   +

E4 - a slowdown in Q4 is expected                                             -0.25                    +

E5 - Bernanke could take upon himself the responsibility
to announce the taper                                                                    +                   -0.5

E6 - the December meeting is followed by a press
conference, a good opportunity to start tapering                              +                   -0.75
communication

E7 - the stock market has risen and the bond market
was flat after the strong NFP report, which could                            +                    -0.5
encourage the officials to start tapering sooner

E9 - inflation is still trending lower                                                -0.5                    +

E10 - the 7% unemployment threshold, which
has been mentioned by Bernanke early 2013, has                           +                     -0.5
been reached        
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                                                            Total                              -1.75               -3.00


Conclusion:

H1 is less invalidated, so it wins. The mechanical conclusion of the analysis is that the Fed will start at least communicating the taper at the next meeting.

What should be seen if, indeed, the Fed were to taper? I would guess that some early signaling by Fed officials (today there are three such speeches) but also the markets could anticipate such a decision somehow - the markets were not taken by surprise in September when tapering was postponed even if everybody was ready for it to happen.

Lastly, the conclusion of this analysis is not to be taken for granted. This framework is more of a way to put arguments in order and to see the pivotal ones. Expressing conviction in probabilities is much better. In this case, I would say there is a 60% chance for the Fed to start at least communicating the tapering.

3 comments:

Anonymous said...

Adi, thanks for the post!

any comments about the market? Sell off soon or already done?

Thanks,

Tony

Adrn said...

The market still looks ready for a bigger correction but the fear of tapering does not seem to be the catalyst, yet. Maybe the low inflation is the reason why everybody is relaxed.

Also, yesterday's Fedspeak did not signal anything, so maybe the market will not fall too much ahead of the meeting.

Anonymous said...

Thank you, Adi.

Tony