Is tapering here to stay this year? Despite a disappointing U.S. payrolls report in December, a number of observers believe that the Federal Reserve will continue to cut back on its monthly bond-buying program.
The Fed announced the start of tapering at the conclusion of its December policy meeting, after noting "further improvement" in the labour market and "the improvement in the outlook for labour market conditions." The statement followed an upbeat payrolls report for November, originally showing job gains of 203,000 before being revised up to 241,000. At the same time, the unemployment rate fell to a five-year low of 7 per cent.
December's report came as a shock: Although the unemployment rate fell further, to 6.7 per cent, payrolls grew by just 74,000, missing expectations by a wide margin. The disappointment caused some head-scratching and open questioning of the Fed's commitment to tapering – given that its bond-buying program, known as quantitative easing or QE, is largely designed to drive employment higher.
But the consensus emerging is that one dud month isn't going to influence the Fed. Credit Suisse believes that the Fed will taper by another $10-billion (U.S.) per month. That will reduce monthly purchases to $65-billion from $85-billion before tapering began. The key here is that inflation could influence the direction of interest rates but not QE.
"As long as inflation remains well below target, the FOMC will have an easier time communicating its dual desire to end QE3 and still remain very accommodative," said Credit Suisse's Neal Soss in a note. "But should upcoming data prompt a rise in inflation expectations, the Fed's commitment to low rates will start looking less credible."
BMO Nesbitt Burns also argues in favour of another "measured taper step" in January (the Fed will release its policy statement on Jan. 29): Despite a disappointing December payrolls report, the average monthly gain is still impressive and the economy is growing at a decent clip.
"As economic growth averages near 3 per cent this year (and payrolls pick up again), we look for the measured taper pace to continue," a BMO Nesbitt Burns note read. "Assuming a final taper of $15-billion, this should end QE by the end of October."
Meanwhile, the Wall Street Journal – long viewed as window onto Fed policy – has given the pro-taper arguments considerable heft with an article by Jon Hilsenrath on Tuesday: "The Federal Reserve is on track to trim its bond-buying program for the second time in six weeks as a lacklustre December jobs report failed to diminish the central bank's expectations for solid U.S. economic growth this year, according to interviews with officials and their public comments.
A reduction in the program to $65 billion a month from the current $75 billion could be announced at the end of the Jan. 28-29 meeting."