Is it Tapering Time Yet?
By Steve Van Order: Calvert Fixed Income Strategist
With recent numbers showing an improved U.S. economic landscape, investors are wondering: is the Fed ready to start tapering?
When talk first began earlier this year that the Fed might begin reducing its monthly bond purchases—or "tapering" its program of quantitative easing (QE)—Chairman Ben Bernanke said the Fed would first need to see clearer evidence that the labor market has improved paired with other signs of economic stability.
The following positive developments from November have more observers questioning whether that time has arrived:
- Manufacturing grew at the fastest pace since April 2011
- More than 200,000 jobs were added, and the unemployment rate dropped to 7%
- The initial estimate for third-quarter economic growth of 2.8% was revised upward to 3.6%, the highest rate since the first quarter of 2012
So, was the jobs report for November good enough? While not a blowout, it was certainly solid enough to raise the probability of a January, or even a December, QE tapering. If so, the amount would probably be on the smaller end of the scale, such as a $10 billion per month reduction from $85 billion to $75 billion. If the Fed opts to wait until March or April, we'd expect the amount to be larger.
Our expectation is that QE tapering will not be announced until next year, probably in March or April, after Janet Yellen has taken over as Fed Chairman. Continued firm economic data, however, could accelerate that timetable into January
When the Fed tapers, we expect it also will signal to markets, through strengthened forward guidance, to expect a hike in policy target rates no earlier than late 2015 and possibly in 2016. It would, however, take a financial crisis or convincing evidence of a recession and/or deflation threat for the Fed to accelerate QE or engage in other easing measures.
The main wild card is whether dysfunctional politics will make another hash of fiscal policy, with federal government funding due to run out in January and the debt limit likely to be hit in the early spring. As we write, a two year budget agreement is working its way through Congress. If passed, it would take some of the "wild" out of the fiscal policy joker. This would mean that incoming economic data will be even more important for the path of monetary policy.
The Economic Recovery is Still Shaky
That upward revision in the third-quarter growth number, while good news, was primarily due to companies increasing their inventories. That trend will not be sustainable as warehouses and store shelves reach capacity. In addition, consumption, which accounts for 70% of U.S. economic output, ran at a lower-than-usual pace in the third quarter. We expect the economy to continue to face uncertainty as well as possible headwinds from federal-government dysfunction.
Effects on the Bond Market
As the Fed's accommodative monetary policy has boosted stocks, prices on Treasuries have weakened – and bond yields have increased.
Better economic data and adjusted tapering expectations are reasons why the yield on the 10-year Treasury note finished November at 2.75%, on the upper end of our expected trading range of 2.51% to 2.76%. Looking ahead, the 3% yield on the ten-year T-note would provide strong support to the market.
While Treasury yields again have increased, we don't expect another bout of selling in the bond market of the magnitude seen in the spring and summer of this year.
This commentary represents the opinions of the author as of 12/13/13 and may change based on market and other conditions. These opinions are not intended to forecast future events, guarantee future results, or serve as investment advice. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither Calvert Investment Management, Inc. nor its information providers are responsible for any damages or losses arising from any use of this information. Calvert may have acted upon this research prior to or immediately following publication. In addition, accounts managed by Calvert Investment Management, Inc. may or may not invest in, and Calvert is not recommending any action on, any companies or securities listed.
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