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Why the Fed Won't Taper

Find exhibit A, below, the section of the Oct. 29-30 FOMC minutes that's got the media selling the investing public the notion of a Fed plan to slowdown its purchases of debt securities is just around the corner.

Exhibit A - Portion of Oct. 29, 30 FOMC meeting minutes

"During this general discussion of policy strategy and tactics, participants reviewed issues specific to the Committee's asset purchase program. They generally expected that the data would prove consistent with the Committee's outlook for ongoing improvement in labor market conditions and would thus warrant trimming the pace of purchases in coming months. However, participants also considered scenarios under which it might, at some stage, be appropriate to begin to wind down the program before an unambiguous further improvement in the outlook was apparent. A couple of participants thought it premature to focus on this latter eventuality, observing that the purchase program had been effective and that more time was needed to assess the outlook for the labor market and inflation; moreover, international comparisons suggested that the Federal Reserve's balance sheet retained ample capacity relative to the scale of the U.S. economy. Nonetheless, some participants noted that, if the Committee were going to contemplate cutting purchases in the future based on criteria other than improvement in the labor market outlook, such as concerns about the efficacy or costs of further asset purchases, it would need to communicate effectively about those other criteria. In those circumstances, it might well be appropriate to offset the effects of reduced purchases by undertaking alternative actions to provide accommodation at the same time."  [emphasis added]

Phrases such as "might, at some stage", "more time is needed" and merely "contemplating cutting purchases" don't read like a plan, at all.  Essentially, the Fed's October FOMC meeting minutes read more like an old Publishers Clearinghouse you-may-have-already-won sales pitch letter than any serious communique of an intent to taper the Fed's debt securities purchases.

In fact, the verbose posturing of a taper in the first half of the paragraph is totally negated by the line: "moreover, international comparisons suggested that the Federal Reserve's balance sheet retained ample capacity relative to the scale of the U.S. economy," which, when translated, means: compared with other nations, the Fed's balance sheet, as a percentage of GDP, is smaller.  See exhibit B, below.

Therefore, in the Fed's way of thinking, further balance sheet expansion may come with no harm in the Forex against its rival currencies, the euro, yen and pound, a theory expressed by Bernanke in prior communiques.

Exhibit B - Total central bank assets/nominal GDP (%)

taper2

However, if the Fed seeks to slow its bulging balance sheet as the data begin to show an improvement toward a fully recovered economy, the evidence overwhelmingly suggests the Fed won't be tapering anytime soon.

Starting with unemployment, the overall data landscape looks quite bleak.

Removing the debate whether the narrower measure of the Bureau of Labor Statistics (BLS) unemployment rate (U-3) is a better assessment of the employment landscape in America than the broader measure of unemployment (U-6), a more reasonable metric (exhibit C), the labor force participation rate, better captures the state of the U.S. job market.  There, especially, the picture appears dire.

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