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The Only 2 Reasons Left to Taper Now

The Only 2 Reasons Left to Taper Now

Kathy Lien, Technical Strategist

With labor and consumer spending clearly losing momentum, the only factors that support Fed tapering this month are more favorable bond market conditions and the lag time between now and the holidays.

Considering the slowdown in consumer spending and sluggish job growth, the US recovery is clearly losing momentum, and it has become increasingly difficult for the Federal Reserve to justify reducing stimulus at next week’s Federal Open Market Committee (FOMC) meeting.

Inflationary pressures are virtually non-existent, which means that if the central bank were to consider a policy action, arguments could be made for both easing and tightening. However, the recovery is stable enough that the Fed is not worried about a sudden contraction in growth, which is why it wants to reduce asset purchases.

At this stage, there are only two motivations for changing monetary policy next week: timing and pricing.

One of the greatest fears for the central bank is that ten-year US bond yields will shoot through 3% when tapering is announced, and luckily, the recent disappointments in US economic data—the most recent of which was today’s retail sales report—have eased the pressure on bonds, so there may not be a better time than now to tweak monetary policy.

December would be a tricky time to reduce stimulus because the meeting is so close to the holidays, and the central bank would then risk sending stocks sharply lower, causing a retrenchment in spending that could make the holiday shopping season particularly painful for retailers.

With this in mind, the Fed cannot justify an aggressive move, so if tapering does happen next week, it may be on a smaller-scale, perhaps only $5 billion to $10 billion per month.

The odds of delaying a reduction in monetary accommodation shot up after today's retail sales report. Consumer spending is the backbone of the US economy, and unfortunately, retail sales growth slowed to 0.2% from 0.4% in the month of August. Although the July figures were revised higher, the improvement does not diminish the grim reality of slower spending.

Excluding autos and gas, the numbers were even more disturbing, as sales growth slowed to 0.1% from 0.6% the month prior. High unemployment, slow income growth, and higher payroll taxes all restrained spending last month.

For policymakers who may have been on the fence, today's report could push them to vote against dialing back asset purchases in September. A number of US economic reports are scheduled for release next week, but this was the last piece of data that could have swayed the central bank's decision.

See related: The Fed’s Last Chance for Clarity

It is no secret that the Fed sees the housing market as the engine of growth for the economy, and the decline in spending on building materials and garden supplies is another reason to be worried.

Producer prices, on the other hand, grew 0.3% in August, but excluding food and energy costs, prices stagnated last month. On an annualized basis, year-over-year PPI growth slowed from 2.1% to 1.4%.

The combination of softer inflationary pressures and weaker consumer spending means that tapering next week is not a done deal. In fact, we expect the US dollar (USD) to continue to weaken ahead of next Wednesday's FOMC policy announcement, as the increased uncertainty and risk encourages a reduction in US dollar positions.

This morning’s University of Michigan consumer sentiment report came in worse than expected as well, yet another reason to expect a near-term correction in the dollar, as well as further justification for being skeptical about the Fed tapering next week.

By Kathy Lien of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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