Every time there’s an upside economic data point added to the picture—yesterday it was industrial production—somebody says, not unreasonably, “…and that’s why the Fed will start to taper sooner than later.” I’ve said so myself.
But as the Fed begins a two day meeting wherein they’ll make that call, they were met by new inflation numbers which could nudge them towards holding off. At least consider these few caveats:
–The figure below shows year-over-year inflation of the CPI-U and the core, both of which remain below the Fed’s 2% target. Yes, the Fed must look forward, but the prices of upstream production—producer prices, which lead the CPI, have fallen on a monthly basis for the past three months and on a yearly basis have averaged about 0.4% over those months.
–There are positive signs of growth from jobs and sales, but we’ve been here before. It’s essential in this biz not to see green shoots through rose colored glasses. Though monetary policy has been exemplary relative to fiscal policy, erring on the side of caution here has a paradoxical meaning (given that it usually means preempting unseen price pressures), i.e., being reluctant to pull back monetary support until there’s convincing evidence that growth has achieved “escape velocity,” i.e., until we’re consistently growing quickly enough to close output and unemployment gaps in the relatively near term.
True, tapering’s not tightening, and it looks like we’ll get a budget deal that takes a bit off of fiscal headwinds next year (though if Congress fails to extend UI benefits, that will blow the other way). There will be no government shutdown. But with inflation as quiescent as it has been, there are downside risks to further dis-inflation, if not deflation, that must be considered as well. Even looking out a bit, it’s hard to see price or wage pressure in either product or labor markets.
As far as I can tell, the Fed has done a good job of convincing traders that they will be data driven. Opinions are generally split as to whether they’ll taper this month or hold until early next year. I raise this point because it means the costs of waiting, in terms of market reaction, will surely be much more benign than in May, when Ben freaked everyone out by merely uttering the ‘t’ word.
One could make a case that some of the data are saying “now.” But I also think it’s fair to read the inflation data and the need to err on the side of caution as saying “wait.”