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Sunday, 15 September 2013

Federal Reserve: Tampering Now or Tampering Later?

Five years since the deterioration of the financial crisis, the Federal Reserve is close to modifying its policy.  Will it do so in September or in December?

In 2008, with the Lehman Brothers collapse, the Federal Reserve began its so-called Quantitative Easing Programs which consisted of purchasing mortgage agency debt security and Treasury bonds. Now, with more than USD 3,000 billion in bonds on its books, the Fed owns a big chunk of the US public debt. By slowing down its purchases, the Fed will set long-term interest rates higher. By doing anything, it would create more expectation. There are already those who advocate for some rate highs by mid-2014. So, when will be the right time to begin tampering?

Mr. Bernanke has often said the unemployment rate is a key component in the Fed’s monetary policy and an optimal target would be 6.5%. However, job creation remains weak. The unemployment rate has declined to 7.3% from 8.1% one year ago mainly due to the private sector, but the labor participation rate has not improved. As a result, postponing any decision until December, when the new Fed chairman will be elected, seems to be a better option. The Fed could instead promise to extend zero interest rates, maybe lowering the interest rate benchmark, in case it begins tampering in September.

In reality, September or December will not make a huge difference. Financial markets have already discounted part of the Fed’s decision. Since April 2013, ten-year note prices have fallen almost 9% and the decline might not be over. Since 1982, yields have increased approximately 16% bottom-to-top, after having fallen about 30% top-to-bottom. The longest period of interest rate decline has been five years (1989-1994). The current yield fall began in 2007-8.

Angelo Airaghi,

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Kevin Watts @ Graduating From Debt said...

Great post! Thanks for sharing this with us.

ProfitsOn said...

Thank you.

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