The U.S. Federal Reserve’s Open Market Committee concludes one of the last three meetings of this year on Wednesday, with the policy announcement due at 2 p.m. EDT, and Chairman Ben Bernanke to speak at 2:30 p.m. (Watch the live media briefing here. We are live-blogging the event here.)
Key Fed players have indicated time and again that a cutback in its $85-billion-a-month bond purchase program isn't a done deal in September. The disappointing August jobs report further clouded the picture.
Sam Wardwell, investment strategist at Pioneer Investments, laid out three possible outcomes of the September FOMC meeting and a handful of questions he said he’d like to ask the chairman.
First up, a human interest question about the former Princeton economics professor himself. With Bernanke leaving the Fed in January, Wardwell asked the question that’s on everyone’s mind -- “Will we ever see you in a classroom again?”
“A lot of people will and a lot of people won’t. Both Bushes went radio silent after they left the presidency,” Wardwell said. “Is he [Bernanke] planning to be radio silent for the next 10 years, or is he going to actually talk about what he learned and try and educate people on what the lessons were?”
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Now, back to the serious stuff.
Scenario I - Taper-Lite: $10 billion
(Possibility: 60 percent)
Wardwell’s call is in line with the consensus. Nearly three-quarters of the 69 economists polled by Reuters following the August jobs report expect the Fed to announce this week that it will trim its asset-purchasing program by $10 billion a month. That compared with just 25 of 41 economists in a poll conducted last month.
Why: Credibility. Central banks put huge weight on credibility, and credibility is earned through consistency. Consistency and credibility are especially important when forward guidance is critical to what the Fed is doing.
“My concern would be if they don’t start [tapering] at all, the bond market might say, ‘Oops, the Fed has blown a bond bubble, the Fed is now panicking, the Fed blinked,’” Wardwell said. “And if the Fed blinks, the market is going to lose confidence in the Fed.”
But given how far the bond market has moved, Wardwell thinks the Fed will be inclined to do “taper-lite” rather than piling on to a bond market which has been selling off in the past couple of weeks.
Question for Bernanke: “In your modeling, how much of a drag do higher interest rates have on the economy?”
According to Wardwell, the Fed’s answer can give him a taste of whether the Fed is more likely to taper "heavy" or "lite" going forward.
Wardwell thinks Bernanke would give the audience an Alan Greenspan-style “mumble, mumble, mumble.”
“We are data-dependent. I don’t know whether I’m going to need sunglasses or an umbrella next Tuesday, I’ll make that decision when I get there,” Bernanke might say.
Greenspan, who ran the Fed from 1987-2006, was known for making long, vague statements on future changes in Fed policy. “If you understood what I said, I must have misspoken,"” Greenspan famously told a senator once.
“The Fed is very careful in its communication, and I’m not sure how much you’ll really learn from Bernanke by asking these questions,” Wardwell said.
Scenario II - Taper Delayed: $0 billion
(Possibility: 20 percent)
When the FOMC meeting concludes Wednesday, policymakers might decide to postpone reductions until a vague date.
Why: The case for not tapering at all (in September) is that the bond market has sold off so hard that the Fed will need to effectively talk the market down again.
“By actively deferring the tapering, the Fed is sending a message, ‘I really don’t want rates to go up,” Wardwell said. “The market will read that body language.”
Question for Bernanke: "Why didn’t you start [tapering]? What has gotten you so scared that you have changed your mind? What do you know that I don’t know?"
According to Wardwell, there’s not enough data coming out between now and the October meeting to really change anything. The August jobs report was a shock, no question about it. But August tends to be a seasonally weak month for hiring.
“The data that came in says to me that the economy is less vulnerable to a setback than the data was 60 days ago. So if anything, I’d say that the case for continuing QE has been diminished rather than strengthened by the economic data that’s come in,” Wardwell stated.
“Not tapering would be scary,” Wardwell added. “It would suggest the Fed knows something really bad, and I would really want to know what that was.”
Scenario III - Taper-Heavy: $20 billion or more
(Possibility: 20 percent)
The Fed said in its July statement that “almost all” of the FOMC members agree that they're “broadly comfortable” with the idea of starting tapering later this year and being finished by the middle of next year. When the Fed says “almost all,” that really means it’s inscribed in stone.
Why: “The reason for heavy tapering would be that in fact the Fed is really confident that the economic data is good and that inflation is not a problem, but that the bond market really needs to normalize. And that it really wants to get out of the QE business as quickly as possible,” Wardwell said.
A research paper presented at the annual Kansas City Fed symposium in Jackson Hole, Wyo., made a good academic case that “the effect of QE3 was blowing a bond market bubble but not stimulating the economy,” Wardwell said.
“It’s sort of like if you’ve got somebody who’s addicted to painkillers, get them off the painkillers,” Wardwell added. “If [QE3] is not doing any good, stop doing it. That’s the case for taper heavy.”
Question for Bernanke: "What’s the Fed’s cost-benefit analysis of QE3? Let’s assume that QE3 goes away at some point, what’s the probability of QE4 if the economy backslides?"
“Bernanke might say, ‘Yes, you know ... QE3 wasn’t worth it,’ in which case you don’t get QE4,” Wardwell said. “But if he said, ‘Hey, it was a very successful program, I’m glad we did it.’ That suggests that QE4 is still in the quiver if the economy slips back again.”
While Wardwell thinks QE1 might have been a good idea, he's skeptical about QE3.
“Let me just put it this way. You are in an auto accident, you are in an ambulance, you are in an emergency room, you are on an operating table, if they haven’t given you painkillers yet, you’ve got a big problem,” Wardwell explained. “Two years, four years later, if you are still on painkillers, you’ve got a big problem.”
“If you go back to May and you see Dow Industrial companies issuing long-term bonds with coupons below the dividend on their common stock, there’s no way that makes sense in an efficient market,” Wardwell said. “'Bubble' is the word that I would use to describe that kind of irrationality.
“I think the Fed is blowing a bubble and I hope they don’t come back with more [QE4],” Wardwell said. “If the Fed does come back with QE4, it’s probably going to be a policy mistake.”