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A Fed Taper Scenario Few Expected

A Fed Taper Scenario Few Expected

Kathy Lien, Technical Strategist

Surprise comments from Fed President James Bullard justified the decision to delay tapering, but also suggested that all options are still open, including larger-scale tapering as soon as October.

The US dollar (USD) is trading higher against all major currencies on the back of comments from St. Louis Fed President and Federal Open Market Committee (FOMC) voter James Bullard. Now, thanks to Bullard, we don't have to wait for the Fed minutes to get a better sense of how tough the decision to maintain asset purchases this week really was.

According to Bullard, the decision was a close one because tapering "by $10 billion is not a big deal." In other words, the central bank felt that by reducing asset purchases by only $10 billion, the impact would be so nominal that quantitative easing (QE) may as well be left unchanged to give the economy its best chance of recovering for the next few months.

In addition to admitting the decision was a borderline call, Bullard left the door open for tapering in October. After holding policy steady, few investors considered next month as a viable option, but Bullard made it clear that the central bank is flexible and could hold a special press conference after the October meeting, if needed.

What Bullard is telling us today is that the Fed is keeping all options open, and despite Wednesday's decision, tapering of asset purchases is near, and when the reduction is made, it should be between $15 billion and $25 billion, an amount officials feel will put a significant dent into the overall QE program.

Essentially, the dialogue about tapering asset purchases this year hasn't ended, and in fact, economists are divided on whether the first reduction would occur in December or in early 2014. We should get more clarity on the FOMC's position in the next week because now that this month’s meeting is over, the quiet period has ended, and a number of Fed Presidents are scheduled to speak.

Today alone, we expect to hear from Fed Presidents Esther George (Kansas City) and Narayana Kocherlakota (Minneapolis), as well as Fed Governor Daniel Tarullo. All three are voting members of the FOMC, and George is a bit more hawkish than both Tarullo and Kocherlakota. The dollar's performance will depend on whether these three important policymakers also believe that tapering this year is still an option.

Meanwhile, the Canadian dollar (CAD) extended its losses against the greenback on the heels of softer consumer prices. Inflationary pressures stagnated in the month of August, with year-over-year gains slowing to 1.1% from 1.3%. Core prices may be slightly hotter, but price pressures are at a minimum right now, which will allow the Bank of Canada (BoC) to keep monetary policy easy.

By Kathy Lien of BK Asset Management

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