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Why markets are fretting over Fed tapering (again) Add to ...

Puzzled by the renewed concerns about Fed tapering? Just weeks after Federal Reserve chairman Ben Bernanke assured markets that tapering didn’t mean that interest rate hikes will follow, and markets seemed okay with that, we are again facing volatility related to a shift in Fed policy.

The S&P 500 is off more than 3 per cent since the start of August, and things turned particularly volatile after last Thursday’s upbeat report on U.S. jobless claims, where claims unexpectedly fell to their lowest level in six years. At the same time, the yield on the 10-year U.S. Treasury bond has spiked to 2.88 per cent, as of Monday, up nearly 1.25 percentage points since May.

It looks as though investors are fretting again over the likelihood of the Fed tapering its bond-buying program, known as quantitative easing or QE – and the impact it will have on the stock market. But what’s more likely is that more investors have come to this conclusion.

Tim Duy, an economics professor at the University of Oregan and a blogger, put it this way: “If you didn’t believe tapering was coming as early as September, and by December at the latest, the initial claims report was something of a wake-up call.”

Yes, he says, some of the recent economic reports have been lacklustre – industrial production and retail sales for example. Overall, though, he argues that the Fed is more likely to see incoming data as evidence that the economy isn’t falling off a cliff. And, more importantly, they are inclined to focus on positive news, which is why declining jobless claims – and the setup to the August payrolls report – are so important.

“I think that fundamentally they are looking to exit asset purchases and refocus attention on the federal funds rates as the first step in policy normalization,” he said on his blog. “Thus I believe that although they might say things like ‘the decision is data dependent’ and ‘the data is mixed,’ they will tend to focus on the positive aspects of the data as justification for moving forward with tapering sooner than later.”

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