Tags: Welsh | Fed | taper | economy

Jim Welsh: Fed May Have to Taper Despite a Cloudy Economy

By    |   Friday, 06 September 2013 08:09 AM

The Federal Reserve faces a muddled picture of the economy as it moves toward a decision this month whether to taper its bond-buying program, but the central bank may have to act regardless, according to Jim Welsh, publisher of The Financial Commentator newsletter.

In a guest column for The Big Picture blog, Welsh said the Fed faces a dilemma of sorts in its tapering decision.

While the Fed is looking for annualized GDP growth of 3 percent by the end of 2013, a drop in unemployment to between 6.5 percent and 6.7 percent and an inflation pickup to 2 percent to justify trimming its monthly $85 billion bond purchases, Welsh said the data are unlikely.

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"The most recent data points on jobs, income growth, consumer confidence, retail sales and housing have generally supported our view that a meaningful second-half acceleration is likely to remain elusive," wrote Welsh, who writes frequently about the Fed's deliberations.

However, hawkish sentiment on the Fed is pressing for the markets to undergo a "sobriety checkup that would lower some of the leveraged positions in the markets," particularly because the Fed's ultra-loose monetary policies have encouraged investors to move into riskier investments, he explained.

Then there is the fact that the Fed has expanded its balance sheet to over $3.5 billion with its purchases of Treasury bonds and mortgage-backed securities. "The Federal Reserve is sitting on tens of billions of dollars in paper losses, and it isn't clear how the Fed will account for them."

Thus while the Fed has claimed its tapering decision is data-dependent, in fact it cannot really allow its balance sheet to balloon bigger indefinitely, Welsh predicted.

One favorable option would be for the Fed to use a "stair-step" approach by cutting its monthly purchases by $10 billion to $15 billion, then wait for subsequent meetings to decide whether to taper again.

Since the Fed has hinted more broadly about trimming its quantitative easing (QE), yields on 10- and 30-year Treasury bonds have soared from 1.61 percent and 2.92 percent, respectively, in mid-May to 2.86 percent and 3.93 percent, respectively, as of August 22, according to Bloomberg.

"Although the Federal Reserve has not tightened policy, the bond market certainly has, so it would be disingenuous for the Federal Reserve to say the tapering of QE3 does not represent a tightening of monetary policy," Welsh said.

The Fed's decision is being watched closely outside of the United States, as well.

According to the Daily Mail, withdrawal of the Fed's monetary support programs "could wreak havoc in emerging markets and dent global growth."

The International Monetary Fund has issued a warning that global policymakers be ready to handle an increase in financial instability in the event of Fed tapering, the Mail reported.

The British newspaper said the economies of China, Brazil and India in particular could be "vulnerable" in the face of Fed action.

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The Federal Reserve faces a muddled picture of the economy as it moves toward a decision this month whether to taper its bond-buying program, but the central bank may have to act regardless, according to Jim Welsh, publisher of The Financial Commentator newsletter.
Welsh,Fed,taper,economy
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2013-09-06
Friday, 06 September 2013 08:09 AM
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