As I recently suggested, the idea that the Federal Reserve will begin to taper its asset buying program next month is less of a slam dunk than many market participants think. The minutes of the Fed’s July meeting, released yesterday, do not add a lot of clarity (from the NYT):
There were hints that some members of the divided committee are comfortable with beginning to ease the Fed’s program of buying $85 billion a month in government bonds and mortgage securities as soon as their next meeting in mid-September. But there were also indications that another camp within the policy-setting group favors waiting until December, or even later.
Incoming data will make a difference, of course, and I take seriously the fact that Ben & Co. have prepared markets for a Sept. taper, but a) they’ve hedged, and b) the fact that financial conditions have tightened fairly sharply in recent weeks should not be ignored.
The 10-year Treasury yield is nudging up to 3%, higher than it’s been since the summer of 2011. Researchers at Goldman track a financial conditions index, which they find to be a reliable predictor of real GDP growth (they’re negatively correlated). It’s up about 30 basis points, due to higher interest rates, wider rate spreads, equity prices, and mortgage rates (I recently raised some concerns regarding higher mortgage rates dampening stimulative refi activity).
Their figure below shows the impact of the GS financial conditions index on GDP growth under three scenarios: it stays flat, it rises (tightening conditions), or it falls. Recent trends would suggest flat or tightening are more likely, though there’s lots of endogeneity—circular causality—in here (if conditions keep tightening and the Fed holds off on the taper, conditions will loosen—I’d guess significantly, as markets are in over-reaction mode). At any rate, if that’s true, the growth impulse turns negative in a few quarters, meaning the Fed will have to once again mark down its forecast.
Perhaps, as the GS folks suggest, they’ll still taper in September but offset it with more forward guidance on the funds rate, i.e., signaling that they’ll keep it near zero for longer. But I wouldn’t be hugely surprised if they held off, or tapered only a tiny bit.
Which is all by way of introducing you to the new mascot, Benji the Tapering Tapir. When will he arrive!?!