The end of the Fed’s taper tantrum
Following Wednesday’s publication of the Federal Open Market Committee minutes, we now know that a reduction in U.S. monetary stimulus could be on the agenda for the next FOMC meeting on December 19. How much does this matter?
When the Fed unexpectedly decided not to “taper” in September, the markets were stunned and gyrated wildly, although investors had only themselves to blame for being wrong-footed in this way. Ben Bernanke had made crystal clear his reluctance to reduce monetary stimulus as long as the U.S. economy appeared to be weakening, which appeared to be the case throughout the summer. By December 19, the situation may well be very different, since the economy will probably be improving and the U.S. fiscal stalemate may well have been resolved. If such improvements happen, the Fed will have no compunctions about wrong-footing investors again, in the opposite direction, as this column suggested last month.
So what will be the impact on the world economy and financial markets if the Fed decided to taper as early as December? The answer is, not much. As long as the Fed stands by its commitment to keep interest rates near zero for the foreseeable future, tapering will have no major economic impact. Therefore its financial significance should also be marginal, except insofar as investor psychology overwhelms rational economic analysis.
Ever since the global “taper tantrum” started six months ago, this column has suggested that investors and business leaders should spend less time on Talmudic parsing of Fed rhetoric and more on analyzing the economic and financial data that will ultimately determine the outlook for the global economy and financial markets, and therefore drive monetary decisions too. For much of this period, investors have chosen to do the opposite, swinging from panic to euphoria and back at the slightest hint of a nuance in the Fed’s verbal contortions. Luckily this neurotic behavior has calmed down in the past few weeks, as investors have reverted to the focus on economic and financial fundamentals that served them well in first few months of this year, before the taper tantrum.
This calmer behavior is likely to continue, regardless of what the Fed decides to do on December 19, for two reasons. The first is that the obstacles to economic growth that largely explained this year’s disappointing performance are gradually eroding, as explained in the FOMC minutes this week: “Acceleration [of the U.S. economy is] expected to be bolstered by the gradual abatement of headwinds that have been slowing the pace of economic recovery — such as household-sector deleveraging, tight credit conditions for some households and businesses, and fiscal restraint — as well as improved prospects for global growth.”
The most important headwind has been “fiscal restraint,” the Fed’s euphemism for the lethal combination of tax hikes and public spending cuts that have squeezed U.S. economic growth by a full percentage point in each of the past four years. In the absence of this fiscal restraint, the U.S. economy would already have returned to something like normal growth. Although U.S. GDP growth since the end of 2009 has averaged only 2.3 percent annually, making this the weakest economic recovery in post-war U.S. history, private sector growth, excluding government consumption and investment, has averaged 3.4 percent, close to a normal recovery pace.
Assuming that a budget deal can be agreed without imposing any further fiscal tightening in 2014 — and this now seems to be an aim shared by both parties’ Congressional leaders and the White House — the growth of above 3 percent already achieved by the U.S. private sector over the past four years should become a reasonable expectation for the economy as a whole. Which leads to the second reason for expecting a calmer market reaction to the Fed’s monetary decisions.
If the headwinds to the U.S. economy abate and GDP growth returns to a normal recovery pace of above 3 percent, the obsession in the business and financial community with trying to second guess monetary and fiscal policies will also diminish. If the economy returns to normal levels of growth, anxieties about fiscal sustainability and budget deficits will be put to rest. Investors, entrepreneurs and consumers will be able to get on with their normal business, instead of worrying about abrupt tax hikes or public spending cuts.
An even bigger benefit of resuming normal rates of economic growth would be a revival of confidence in monetary policy. If Fed policy finally seems like it is achieving the results that Ben Bernanke intended and promised — decent growth and a gradual reduction of unemployment — investors and business leaders will stop panicking about marginal monetary adjustments such as tapering and focus instead on the monetary policy decisions that really matter. These are all about interest rates — and in terms of interest rate decisions, both now and in the future, the Fed under Janet Yellen looks to be even bolder than the Bernanke Fed.
Not only has Yellen been more explicit than Bernanke in promising to keep U.S. interest rates near zero long after unemployment falls below the Fed’s 6.5 percent threshold, but the FOMC is now uniting behind additional stimulus. This week’s minutes suggested, for example, that when the tapering decision is taken it will be accompanied by a further cut in the interest paid to banks on reserves parked at the Fed. The purpose will be to underline in the clearest possible manner that tapering implies no wavering in the Fed’s commitment to zero rates.
In short, the outlook for monetary policy is now as clear and stable as it has ever been. Short-term interest rates will remain near zero for years ahead — and this applies in Europe, Britain and Japan, as well as the U.S. With monetary policy around the world now set in stone, investors and business leaders can stop throwing tantrums about central bankers and get back to the serious business of deploying capital and creating jobs.
PHOTO: Janet Yellen and current Fed Chair Ben Bernanke listen as U.S. President Barack Obama announces his nomination of Yellen to head the Federal Reserve at the White House in Washington October 9, 2013. REUTERS/Jonathan Ernst