James Saft, Reuters Columnist
The Fed’s non-taper is one of those times.
The US central bank is encouraging you as an investor to sit back, enjoy the warm water and take on some risk.
For now, maybe not for long, but for now, that is probably what you should do.
The Federal Reserve’s decision not to begin to cut back on its purchases of bonds caught investors unawares on Wednesday. Economists and Fed watchers had been in virtually unanimous agreement that the bank would shave back, or taper, bond purchases, with most of the debate centred on how they might sugar the pill by providing guidance indicating that interest rates might stay low for longer than anticipated.
Instead the Fed put off the taper and left investors remarkably unsure about why or when they might begin.
“The Fed’s actions are consistent with the idea of being ‘credibly irresponsible’. That is an intention to support demand via, among other channels, an increased perception of higher risk and greater inflation risk,” interest rate strategists at Societe Generale led by Vincent Chaigneau wrote in a note to clients.
“The FOMC is giving us an invitation to take on risk. There is no reason for investors not to accept the gift.”
That’s really about all there is to it. So long as we both think we understand what the Fed is telling us and believe that it retains credibility as a central bank things are very straightforward. The answer to the first part is that yes, by delaying, the Fed is clearly trying to put in place conditions in which risk-taking is rewarded. And yes, though there is an irony in the Fed botching its communications and it retaining credibility, this is the single most credible central bank in the world today, making it the single most credible central bank in human history.
How long, oh Fed, how long
Nothing lasts forever, and clearly accommodative policy will at some point have to end, or at least begin to end.
Bernanke cited three main reasons for the delay. First, the data, second the effect of the tighter conditions in financial markets and third, the upcoming budget battle in Washington.
On the data front, it would be hard to expect them to change course after only one month’s more data, making an October taper look unlikely. The process of raising the budget ceiling, much less agreeing a longer-term deal, also won’t be complete by then, pointing to December.
And indeed, according to a Reuters poll on Wednesday, economists at 9 of 17 primary dealers surveyed after the Fed announcement said it could announce a taper at the end of its December 11–12 policy meeting, with only one choosing October.
Even December might be too soon. First off, the economy is not looking as if it is building up towards escape speed. While the jobless rate is improving, Bernanke hinted that if anything the Fed might wait longer, referring to the unemployment rate as “unreliable.”
“There are no magic numbers for setting policy,” Bernanke said. That undid a summer’s worth of forward guidance from the Fed, but did so in a way which is profoundly bullish.
There is also the transition issue. It is possible that Larry Summers’ decision to step down from consideration for the top job at the Fed allowed Bernanke to take his time in changing direction in monetary policy. Watch next week for the possible appointment of Fed Vice Chair Janet Yellen as the next head of the bank. If that happens, Bernanke might be more willing to head off into the sunset when he leaves the post at the end of January without having started to taper.
There are, of course, lots of caveats and plenty to fret about.
Not only has the Fed suppressed volatility through liquidity, it has set itself up for considerable volatility in the future because investors will have less confidence in their ability to predict policy. Volatility is expensive in financial markets, and at some point that bill will be paid.
As well, when the Fed does finally begin to taper, valuations are likely to have strayed further from the underlying fundamentals.
All of that is in the future, and for the next couple of months investors should rest their minds, enjoy the gains and wait for a better time to sell.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. You can email him at jamessaft@jamessaft.com)