More Tapering Talk: Fed and the Market Remain on Different Pages

     In May the market was jolted by the minutes of the FOMC meeting which suggested that the Fed might start pulling back on bond buying sooner than expected.

     If anything, today's news was even more of a jolt as half of the FOMC now thinks the Fed should end bond buying altogether by the end of 2013.

     The minutes suggested that Fed officials are split on the timing of when the central bank should wind down its easy-money policies. About half of officials support ending its bond-buying program entirely by the end of the year, which "caught people by surprise," said John Canally, investment strategist and economist with LPL Financial, which advises on roughly $130 billion in client assets.

"The market needs to be convinced by the Fed that if it is [withdrawing stimulus], that means the economy is strong enough to withstand it," he said, but added that investors haven't been persuaded. "The market and the Fed remain disconnected."

      http://online.wsj.com/article/SB10001424127887324879504578597263274233902.html?mod=WSJ_hp_LEFTWhatsNewsCollection

      Hence the title of this piece as the Fed and the market still aren't on the same page. For all this, however, the market wasn't crushed. There is an argument that the market is becoming less sensitive to Fed action-that corporate earnings which have just started are more important. If that's the case then the Fed may feel it can get away with 'tapering.' 

    The market then rallied when Bernanke said that he expects policy to be easy for the foreseeable future with interest rates staying near zero until at least 2015. 

       Federal Reserve Chairman Ben Bernanke said on Wednesday that the U.S. economy continues to need highly accommodative monetary policy. 

Answering questions at a conference sponsored by the National Bureau of Economic Research Bernanke said that when looking at the Fed's dual mandate on employment and inflation more work needed to be done.

He said the 7.6 percent unemployment rate probably "overstates the health of the labor market" and that inflation remains below the Fed's 2 percent target. Moreover, fiscal policy remains "quite restrictive," Bernanke said.

       http://www.cnbc.com/id/100877586

       There's been lots of debate over the market action over the last few months. A relative rise in interest rates-mortgage rates and Treasuries have also thrown many for a loop. 

       Scott Sumner's explanation for what we've seen?

       "My best guess is that two things have happened in recent months:

       1.  Growth is stronger than the markets (or I) expected.

    2.  The Fed will respond to any given level of growth with more aggressive “tapering” than expected.

     "That one-two punch seems to have driven 5 and 10 year bond yields much higher than I expected.

    "I use the term “tapering” because I don’t mean to suggest than monetary policy will gradually become more contractionary, indeed I expect just the opposite.  But it will look more contractionary to most people."

    http://www.themoneyillusion.com/?p=22156&utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+Themoneyillusion+%28TheMoneyIllusion%29

     So for Sumner 'tapering' is something different from being contractionary. In the face of the fact that half the Fed officials at the last meeting want to end bond buying soon how can he argue that Fed policy will become easier? I suppose he means relative to actual economic conditions. After all, we're supposed to see unemployment under 7 next year and yet the Fed plans to have interest rates at 0% for at least the next two years. In the same way he argues that Fed policy was contractionary in late 2008. 

     I was just reading more about the Fed in late 2008. It is interesting that with all the unprecedented moves to save Fannie and Freddie, AIG, and the TARP, even then the Fed left interest rates at the same level-2%. It didn't cut immediately. Again, 2% historically speaking is low but there is still a lot of room-it remains far from the 'zero bound' that Sumner claims has now been debunked. 

    Yichuan Wang thinks that Fed tapering won't have too much bad effect on the market-today seems to support that thesis. Still, he does think it's a mistake and won't do the larger economy any good. 

    " it’s not clear if the taper will be all that “terrible” for equities. Of course, the human cost of tight monetary policy is enormous. I personally believe that the Fed should not taper in the face of such elevated levels of unemployment and depressed levels of nominal GDP. Nonetheless, the taper is likely to have only moderate impacts on the stock market, in spite of what short term correlations may suggest."

     http://synthenomics.blogspot.com/2013/07/where-did-reach-for-yield-go.html

      Krugman thinks the 'tapering' certainly is terrible.

      http://krugman.blogs.nytimes.com/2013/07/07/that-terrible-taper/