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.”