(The author is a Reuters columnist. The opinions expressed are
his own.)
By James Saft
Aug 27 (Reuters) – Looked at in isolation, the economic data
in the United States does not argue for the Federal Reserve to
cut back on its bond purchases starting in September.
Yet markets and economists continue, in the main, to expect
the so-called taper, a process where the Fed begins to reduce
the $85 billion per month it buys in bonds, to be announced at
its September meeting.
On the face of it, that expectation should have been dealt
two massive blows by data about new home sales and the purchase
of big-ticket durable goods released on Friday and Monday.
Sales of new single-family homes in the U.S. dropped 13.4
percent in July, as the impact of rising mortgage rates, driven
higher themselves in anticipation of the taper, cut into buyers’
animal spirits. The revival of housing, which drives jobs and an
array of spending, has been a centerpiece of arguments that the
U.S. economy is recovering.
That same cooling is already being felt in the market for
new washing machines and heating systems, to judge by the sharp
decline in sales of durable goods in July, which fell by 7.3
percent in the biggest drop since last August. Non-defense
capital goods orders excluding aircraft, which is tightly
correlated to business spending intentions, fell 3.3 percent.
Core capital goods actually shipped fell by 1.5 percent in July,
the biggest drop since the crisis year of 2008.
Stocks and government bonds rallied on the news, but not in
the convincing, full-throated way you would expect if investors
had come to believe the taper was off the table.
One of two things seems likely in the coming days.
The Fed, by which I mean Chairman Ben Bernanke and his core
supporters, may move to create an impression that the central
bank wants to see more, and better, data before it begins to
shave back bond purchases. This could be a speech or series of
comments by Fed officials, or it could be a story in the press
citing sources within the central bank. If this happens, look
for a stomping rally, and an equally joyous run-up in emerging
markets, which are facing keen currency and funding pressures
due to taper anticipation.
The alternative also involves news out of the Fed, but this
time indicating that the taper in September is still planned,
but perhaps stressing that the impact on the real economy will
be slight, or in some other way minimizing it as a formality –
the beginning of a long process of normalization. In other
words, the taper will happen, but don’t worry, it never was that
big a deal in the first place.
GAP BETWEEN LOGIC AND JUSTIFICATION
If the latter happens, markets will not be happy. In part,
risky assets will be hurt because indeed the effect of bond
purchases was primarily felt in financial markets, where
investors were pushed to take cash they got from the Fed and buy
something, anything, with a higher potential return.
However, when the stated reason for something happening
doesn’t justify it, it is time to start looking for another
underlying driver, perhaps one that is harder and more dangerous
to say out loud.
It would be hard for the Fed to say it is tapering because
bond buying hasn’t worked that well, and that the risks – of
bubbles on the way up and market dislocation on the way out –
look like they may outweigh the potential benefits. Central
banks don’t like to sound like they are being forced into a
position, and no one likes admitting that a gambit has not paid
off.
To be clear, there are some bright spots in the economy. The
debt burden shouldered by households has improved, and the
federal deficit has been declining – from more than 11 percent
of output in 2009 to about 4 percent his year.
Housing is another bright spot, but that makes Friday’s new
home sales that much more chilling. Ten-year bond yields have
jumped from 1.63 percent in May, when the taper talk began, to
about 2.8 percent now, taking mortgage rates higher with them.
While a lot of home sales are cash to investors, those
investors are actually highly sensitive to the risk environment.
As rates rise, cash buyers will fade along with traditional
mortgage borrowers.
All this is to say that the emphasis on the taper by the Fed
is puzzling if you only take into account what the central bank
actually says, and compare it to the data the economy is
actually recording.
The truth probably is that the taper is good risk
management, needs to happen, but will be painful. Don’t expect
those words to come out of Bernanke’s mouth, or his successor’s.
(At the time of publication, James Saft did not own any
direct investments in securities mentioned in this article. He
may be an owner indirectly as an investor in a fund. You can
email him at
and find more columns at http://blogs.reuters.com/james-saft)
(Editing by Douglas Royalty)
