Wednesday, January 08, 2014 - Tapering is Not Tightening

Tapering is Not Tightening

by Sinclair Noe

DOW – 68 = 16,462
SPX – 0.39 = 1837
NAS + 12 = 4165
10 YR YLD + .06 = 2.99%
OIL – 1.15 = 92.52
GOLD – 5.90 = 1226.90
SILV - .32 = 19.62

Repeat after me: “tapering is not tightening.” This is the new mantra of the Fed; tapering is not tightening.

Today we got the minutes of the Fed FOMC policy meeting of December 17-18, and one of the themes is that the policy setting members of the Fed want to proceed with caution in trimming asset purchases and tapering is not on a rigid preset course; it is subject to incoming economic data and tapering is not tightening.

You will recall that the Fed announced it would cut purchases by $10 billion per month, while still making $75 billion a month in purchases of mortgage-backed securities and Treasuries. The minutes reveal “concern about the potential for an unintended tightening of financial conditions if a reduction in the pace of asset purchases was misinterpreted as signaling that the committee was likely to withdraw policy accommodation more quickly than had been anticipated." So, it's just a little tapering, not tightening.

That said, even the more dovish policymakers had to concede that QE does not pack the punch it might have once packed. From the minutes:

Regarding the marginal efficacy of the purchase program, most participants viewed the program as continuing to support accommodative financial conditions, with a number of them pointing to the importance of purchases in serving to enhance the credibility of the Committee’s forward guidance about the target federal funds rate. A majority of participants judged that the marginal efficacy of purchases was likely declining as purchases continue, although some noted the difficulty inherent in making such an assessment. A couple of participants thought that the marginal efficacy of the program was not declining, as evidenced by the substantial effects in financial markets in recent months of news about the likely path of purchases.

This is not surprising, that the marginal efficacy has been declining; first, we would have to establish that there was efficacy in the scheme to begin with. OK, let's grant that QE had an effect; it certainly served as rocket fuel for the stock market and it was like bionic legs for the housing market, even if it didn't do much more. But there are limits.

The Fed has sopped up nearly a third of the Treasury market, and if they don't cut back significantly, they'll have half the market by the end off the year, and they would basically have everything on their balance sheet by 2018. This would create a liquidity problem for anybody seeking high quality collateral, and that might be problematic. Liquidity is not a problem right now, and even if the Fed continues with purchases, because they are not on a preset course with the taper, remember that there are still plenty of other central banks in the world and they have lots of liquidity to bring to the party.

But before the Fed could ever get that far, there was the concern about bubbles, or as the minutes tell us: Participants were most concerned about the marginal cost of additional asset purchases arising from risks to financial stability, pointing out that a highly accommodative stance of monetary policy could provide an incentive for excessive risk-taking in the financial sector. It was noted that the risks to financial stability could be somewhat larger in the case of asset purchases than in the case of interest rate policy...

You can see how the fear of bubbles, although the Fed would never call it a bubble, the fear of financial instability might be cause for the Fed to step back from its monetary experiment. The big banks have surely been feeling their oats, what with the Fed's Zero Interest Rate Policy, and the QE, and then the Department of Justice and SEC providing get out of jail free cards for everything from robo-signing to money laundering to well, everything.

And then back to the idea of marginal efficacy, maybe the Fed was feeling a little remorse that all the billions in asset purchasing did so very little for Main Street; maybe there was a hint of awareness of the dual mandate of price stability and maximum employment, which remains so far away. While the employment situation has been improving, it is still nowhere near maximum. We'll find out more about the direction of the the labor market on Friday with the monthly jobs report.

In a precursor to the Friday report, today ADP gave its private report showing private employers added 238,000 jobs in December, and the November figure was revised up to 229,000 from the initial estimate of 215,000; this marks the fastest pace of hiring in 13 months. The ADP report doesn't always match with the official government report, but we might guess that the Friday report will be a little stronger than the current estimates of 195,000 new jobs. Maybe.

In another positive read on the economy, the National Federation of Independent Business said small businesses hired the most workers in nearly eight years in December. In a separate report, retail industry tracker ShopperTrak reported sales rose 2.7 percent in the November-December holiday shopping season, but much of that was from promotions and discounts.

Also, the Mortgage Bankers Association reported today that applications for home mortgages rose 2.6% in the last week, rebounding from a 13 year low in the last week of December. And the Federal Reserve reports that consumer borrowing increased by $12.3 billion in November to just over $3 trillion, which pretty much matches the Fed's balance sheet after all the purchases from QE (just coincidentally). Almost all of the November increase came from an $11.9 billion rise in borrowing for auto loans and student loans. 

Fifty years ago today, then president Lyndon Johnson delivered a State of the Union address and he declared an “unconditional war on poverty”. At the time it was dismissed as so much rhetoric, but it was a significant shift in policy. Despite nostalgic reminiscence, poverty was a real problem. The idea of the massive middle class society enjoying postwar prosperity was less than a complete picture. About one-third of all Americans, 40-50 million people lived below those standards which we have been taught to regard as the decent minimums for food, housing, clothing and health.

The policies adopted as part of LBJ's War on Poverty included Medicaid, Medicare, subsidized housing, Head Start, legal services, nutrition assistance, raising the minimum wage, food stamps and Pell grants. And it worked, imperfectly, but it worked. The nation's poverty rate was cut in half, from 22.2 percent in 1960 to an all time low of 11.1 percent by 1973. Most dramatic was the decline of poverty among the elderly, from 35.2 percent in 1959 to 14.6 percent in 1974, thanks to enactment of Medicare in 1965 and cost-of-living increases for Social Security. The poverty rate among African Americans fell from 55.1 percent in 1959 (when most blacks still lived in the rural South) to 41.8 percent in 1966 (when blacks were an increasingly urban group) to 30.3 percent by 1974. But the victories in the war on poverty were short-lived.

Since 1964, the nation's population has roughly doubled while the actual number of people living in poverty is about 50 million, which works out to about 15% of the population, living below the poverty threshold. Almost as many poor people live in the suburbs as in cities -- a phenomenon that was unthinkable 50 years ago. About one-quarter (22 percent) of America's children now live in poverty. The poverty rate is much higher for Blacks (27 percent) and Latinos (26 percent) than for whites (10 percent). A significant proportion of America's poverty population are the working poor, who earn poverty-level wages.

Even more startling is the fact that 100 million people comprise what the US Census calls the poor and the "near poor," based on a new definition of poverty that measures living standards, not just income. Almost one-third of the nation, in other words, can barely make ends meet.

In the early 1960s, many Americans were ready to enlist in a war on poverty because the standard of living was improving for most families, inequality was shrinking, and people felt hopeful about the country and its future. A growing number of American families were able afford to move to the suburbs, buy homes, install air conditioners, purchase a TV, pay for a new car every few years, take a yearly vacation and even fly on an airplane. They could send their children to college and save money for a comfortable retirement. If rising affluence made a war on poverty possible, the civil rights movement and Cold War made it necessary.

During the past decade, ordinary Americans have experienced declining wages, rising joblessness, and an epidemic of foreclosures. Some pundits argue that it is difficult to elicit a generosity of spirit among economically-squeezed middle-class families. But as more and more middle class Americans face economic insecurity, they may identify their own fate with the plight of the poor. It's easier to slip into poverty than to climb out of it. Income inequality is greater in the United States than in other rich countries and Americans should be offended that a child born into poverty has such a hard time escaping it.

Within a decade after President Johnson declare a War on Poverty, we cut the nation's poverty rate in half. It is inaccurate to say that the War on Poverty failed. Without anti-poverty programs, the nation's poverty rate would likely be twice as large; and at the rate we're going, it might be.