*To gauge the likelihood of a December taper, we should think through the changes that might occur in the first paragraph of the FOMC’s statement, which is always a brief assessment of the state of the economy.
*While the committee will surely tweak its language on account of last week’s strong jobs data, we’ll see downgrades in other parts of its assessment, which should include a reference to weaker business investment growth and possibly a renewed warning about rising mortgage rates.
*The committee should also be concerned about holiday spending after seeing rapid inventory accumulation in Q3 GDP and other indicators.
*Inventory and spending concerns may not be recognized in the statement, but they’ll add to the case to let the dust settle on the fourth quarter before changing existing policies.
*We expect the tapering decision to be deferred to the next meeting once again.
To know your enemy, you must become your enemy -Sun Tzu
In war, poker, chess and many other endeavors, wise old hands will advise you to think like your opponent. We’ll try a related idea here by seeing if we can think like the members of the Federal Open Market Committee (FOMC). Specifically, we’ll pretend to write part of the statement for the FOMC’s December 17/18 meeting.
We’ll work through the four or five sentences in the statement’s first paragraph that sum up the committee’s thoughts on recent developments. When the FOMC makes a policy change, it’s always linked to these four or five sentences. Here’s what they said in the last statement (for the meeting on October 29/30):
Indicators of labor market conditions have shown some further improvement, but the unemployment rate remains elevated. Available data suggest that household spending and business fixed investment advanced, while the recovery in the housing sector slowed somewhat in recent months. Fiscal policy is restraining economic growth. Apart from fluctuations due to changes in energy prices, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable.
As you may know, there are at least five pieces to this section: employment, household spending, business investment, housing and inflation. In addition, sometimes factors outside the big five become important enough to make a special appearance. For example, every one of the last six statements included a sentence on fiscal restraint.
We’ll look at each area in up to four steps: old language, new information, comparison andnew language. Here are the questions we’re trying to answer:
Once we’ve covered each area, beginning with employment below, we’ll explain why our answers tell us to expect another non-taper.
Old language (October): “Indicators of labor market conditions have shown some further improvement, but the unemployment rate remains elevated.”
Old language (September): “Some indicators of labor market conditions have shown further improvement in recent months, but the unemployment rate remains elevated.”
Comparison: Nonfarm payrolls strengthened considerably, but these gains aren’t corroborated by the household survey.
New language: The committee is likely to either restore September’s “shown further improvement” (dropping the qualifier “some” from October’s statement) or upgrade the language even more by mentioning an increased pace of hiring. On the other hand, the household survey’s disturbing trends may warrant an extra qualifier. The part about the unemployment rate remaining “elevated” will appear for the 18th consecutive time.
Old language (last 8 meetings): “Household spending advanced.”
Comparison: While the data looks weaker than it did at September’s meeting, the holiday season is the most important piece and still uncertain.
New language: There’s a small chance that they’ll downgrade the language to say that the rate of spending growth has slowed. For this to happen, the December 12 retail sales report would need to be weak. Otherwise, expect to see “household spending advanced” once again.
Old language (last 7 meetings): “Business fixed investment advanced.”
Comparison: Recent data paints a much weaker picture than at September’s meeting, when the only weak spot was a single month’s data (for July) from the durable goods report.
New language: Expect the new wording to be similar to “growth in business fixed investment has slowed,” which was the language used in December 2012 after the last drop in business equipment spending.
Old language (October): “The recovery in the housing sector slowed somewhat in recent months.”
Old language (September): “The housing sector has been strengthening but mortgage rates have risen further.”
Comparison: Permits recovered since the last two meetings, but new home sales were disappointing apart from October’s reading. The Housing Market Index and Pending Home Sales Index also weakened. Mortgage rates are rising once again, which will surely get the committee’s attention.
New language: Expect a newly worded housing sentence that retains the cautionary tone of the recent statements. If mortgages rates remain above 4.5%, they’ll probably restore September’s qualifier about rising rates. If rates continue to rise AND the mid-December releases (NAHB index, starts and permits) are weak, the new language should be a clear downgrade from the last two statements.
Old language (last 5 meetings): “Fiscal policy is restraining economic growth.”
New information: The effects of fiscal measures enacted early this year (the tax hike and sequester) will gradually diminish. While new measures could be agreed at any time as budget negotiations continue, fiscal drag isn’t likely to be as severe as it was in the 2013 fiscal year.
New language: The old language could and probably should be softened this month. They could add a qualifier to indicate that the effects are diminishing or eliminate the sentence altogether (less likely).
Old language (October and September): “Apart from fluctuations due to changes in energy prices, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable.”
New information: Core PCE inflation (the FOMC’s preferred measure) fell from 1.2% as of September’s meeting to 1.1% currently.
New language: Same as the old language.
The statement will be upgraded in parts but with a few downgrades mixed in. Overall, it’ll be less sanguine than you might expect if you’ve only been scanning headlines and watching financial television. It’ll reflect disappointing data in areas that haven’t received as much attention as, say, the nonfarm payrolls report, which caused many pundits to forecast a December taper. These more disappointing areas include business investment, mortgage rates and the shrinking labor force.
Based on the balance of upgrades and downgrades, some FOMC members will surely caution against an overreaction to a few months of 200,000+ (barely!) nonfarm payroll gains. They’ll also consider the huge inventory build shown in this year’s GDP reports, which may not be mentioned in the statement but should be part of the discussion. Not only do rising inventories help to explain the consensus outlook for weak Q4 GDP growth, but they also present risks for 2014.
What’s more, it’s hard to judge the fourth quarter without the full picture on holiday spending, which isn’t yet available. The importance of holiday spending makes mid-December an awkward time to form conclusions about the economy’s direction, and that’s especially true this year due to the government shutdown and late Thanksgiving. Some FOMC members will want to wait for the dust to settle on the fourth quarter before making policy changes.
Taken together, these factors suggest another non-taper in December . If we’re right, the spotlight on January’s meeting – which already features Ben Bernanke’s exit, Janet Yellen’s new role and a new set of voters – will be even brighter.
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