Five central banks meet during the first week of March, with no change in rates expected but perhaps a rousing comment or two. The Fed doesn’t meet until 19-20th March amid talk that the policy committee is certainly contemplating and may speak of tapering off QE3. More than one big bond market player thinks this will be the breakout year for US bonds, with yields rising to 2.75% or as much as 3.50%.
Even if the market doesn’t freak out over the Fed taking the punchbowl away, surely the Fed sees such a change – from 1.5% to 3.5% – as a shock, and preventing shocks is part of the Fed’s job description. But shock is the last thing on the Fed’s mind, since it has no intention of changing QE, even after the qualification is met to do so.
We know because straight shooter Vice Chair Yellen said so. Speaking to the National Association for Business Economics, Yellen said, “At this stage, I do not see any [costs] that would cause me to advocate a curtailment of our purchase program.”
The press keeps saying she is a possible replacement for Bernanke after his term ends in January 2014. We say, “When pigs fly.” Congress doesn’t like women smarter than they are (vide Elizabeth Warren), which is a distressingly high number, not to mention that Congress doesn’t understand QE in the first place.
The biggest potential cost of the current policy is financial market stability. But, “At this stage, there are some signs that investors are reaching for yield, but I do not now see pervasive evidence of trends such as rapid credit growth, a marked buildup in leverage, or significant asset bubbles that would clearly threaten financial stability.”
Besides, ending or tapering off QE is not the end of accommodation, it just a reversal of rising accommodation. And when accommodation has peaked:
“The Committee’s intention is to leave that accommodation in place until well into the recovery. For example, the Committee could decide to defer action even after the unemployment rate has declined below 6.5% if inflation is running and expected to continue at a rate significantly below the Committee’s 2 percent objective. Alternatively, the Committee might judge that the unemployment rate significantly understates the actual degree of labor market slack. A decline in the unemployment rate could, for example, primarily reflect the exit from the labour force of discouraged job seekers. That is an important reason why the Committee will consider a broad range of labour market indicators.”
In other words, the US economy may qualify for ending QE in the form of unemployment at the target 6.5%, and the Fed still won’t taper off QE. It will find some other bit of labour market data to justify hanging on.
Finding some other excuse won’t be hard. We get nonfarm payrolls this week, probably a rise of 160,000 from a forecast range of 125,000 to 225,000, according to Market News, with the unemployment rate down 0.1% to 7.8%. This looks good to some. But if we step back and consider that employment growing at 150,000 is only “keeping up” with the natural growth in the labour market, a 10,000 rise over that to the consensus 160,000 is actually pretty bad.
Even a rise to 225,000 is only 75,000 jobs over the rate needed to keep a growing population occupied, and that’s not considering the participation rate, which is presumably backed up to the gills with frustrated no-longer-looking job seekers.
In other words, traders and analysts alike see the payrolls number only in the context of the expected forecast range and recent outcomes, not in the context of the overall economy.
As Yellen pointed out, the Fed’s aggressive stimulus is warranted in the context of the economy operating so far below its capacity. We are so hungry for recovery talk and recovery data that bad data can appear to be “good”, if it’s only less bad than total disaster.
Our deduction is that if the market were valuing Yellen’s remarks appropriately, and we have to believe she speaks for Bernanke, too, the recovery is still weak and uncertain. Therefore, the US is not making the world safe for risk. The dollar should be bought as a safe-haven.
On the other side of the coin, the Fed is going to continue accommodation indefinitely, even beyond where the data seems to show it should be pulling back. Therefore, the dollar should be sold on the persistence of the “dovish” mentality.
Which will win? Well, nobody knows yet – the bond gang is pretty smart. It should conduct a reality check sometime soon and push yields back toward 1.50%. The dollar will run out of steam, and abruptly – no matter what the political and institutional risk in Europe.
We don’t have the stomach for another European crisis – see the drop in peripheral sovereign yields from the jump right after the Italian election – but we always have an appetite to trash the dollar.