The Fed will consider the overall health of the economy and its core components to decide on tapering today, including strong points like housing and manufacturing, and weak spots like labor and consumer spending.
It’s been seven weeks since the last Federal Reserve monetary policy meeting, and we have seen many economic releases since then. There have been some improvements as well as deterioration, but where it really counts (jobs and consumer spending), the US economy has weakened.
As shown in the table below, retail sales growth has been sluggish since the beginning of the year, but in August, core retail sales declined by 0.1%. This retrenchment in spending was caused by weaker job growth and a decline in consumer confidence. The unemployment rate improved, but unfortunately, this was due to a drop in the participation rate, and not an increase in job growth.
The housing market seems to be performing better, even with this morning's larger-than-expected drop in housing starts and building permits because the data is stronger than the June figures, which the central bank had on hand at its last meeting. The manufacturing and service sectors also experienced stronger expansion last month.
Guest Commentary: Core Segments of the US Economy
In all, it can be argued that amidst the weakness, there is also strength, and for the Federal Reserve, we believe there's enough momentum in the economy to justify calculated tapering of asset purchases.
A reduction in quantitative easing (QE) should be positive for the dollar, but investors can't assume that the dollar will automatically rally post-FOMC. Strategically, the Fed will most likely strive to underwhelm, with the hopes of preventing a collapse in stocks, and limiting any spikes in the dollar and US Treasury yields. To do so, the Fed will need to clearly communicate that tapering does not equal tightening, and that it stands ready to step up bond purchases again if the economy weakens, and as we discussed previously, there are five tools that can be used to effectively manage down expectations.
See also: The Fed’s 5-Tool Crash-Prevention Kit
By Kathy Lien of BK Asset Management