Ben Bernanke
Will we ever see you in a classroom again? REUTERS/Jim Young

Healthy job gains, a falling unemployment rate, strong consumer spending and a budget deal likely to win final passage this week have increased the chances of a quicker start to tapering. While it remains a close call, most economists do not expect the U.S. Federal Reserve to pull the trigger at its policy meeting Tuesday and Wednesday, due partly to a below-target inflation rate and the expiration of jobless benefits.

“We think that the Fed can afford to -- and will -- wait several months more before tapering QE, gathering evidence that the recovery is entrenched and that inflation is picking up,” said Thomas Costerg, U.S. economist at Standard Chartered Bank, in a note.

The U.S. Federal Reserve’s Open Market Committee concludes its last meeting of 2013 on Wednesday, with the policy announcement and updated economic projections due at 2 p.m. EST. Chairman Ben Bernanke will hold his quarterly press conference at 2:30 p.m., his last as chairman.

The Fed has said it will slow its $85 billion monthly bond-buying program when certain economic indicators meet its targets.

According to a Reuters poll conducted last week, 22 economists expect the central bank to act in January, while 32 said the Fed would wait until March to make its first move. Only 12 economists expected an announcement this week. That said, expectations for an earlier move are rising. One month ago, 37 anticipated tapering to start in March, 16 said January and only three saw a December taper.

A Bloomberg survey also confirmed the shift in sentiment. A Dec. 6 survey by Bloomberg showed 34 percent of economists said the Fed will begin reducing monthly bond purchases at this week’s meeting. That compares with a Nov. 8 survey that showed 17 percent expecting a December taper.

Bank of America Merrill Lynch is in the March tapering camp. The firm currently places a 25 percent probability on a December taper, 30 percent on January and 35 percent on March. Goldman Sachs also sees March 18-19 as the most likely date for the first taper.

UBS is sticking with its call that the first tapering of QE will be announced at the Jan. 28-29 FOMC meeting, with the actual taper beginning in March. “We look for a modest initial taper of $10 billion, concentrated in Treasury purchases,” UBS Chief Economist Maury Harris said in a note.

Capital Economics, while noting it’s a close call either way, is putting its bet on Wednesday. “We suspect that the renewed strength of employment growth in the past few months will be just enough to persuade the Fed to begin tapering … on Dec. 18,” the firm’s Chief U.S. Economist Paul Ashworth said in a note.

The Case For A Sooner Taper

U.S. economic data continue to firm up, and growth prospects are improving. The latest Reuters poll showed economists revising their consensus growth estimate for all of 2014 to 2.6 percent, up from 2.5 percent in the November poll.

Payroll growth is on track for the best year since 2005. U.S. businesses added more than 186,000 jobs a month on average so far in this year, compared with 182,750 in 2012. The Fed blinked in September, when it learned that employment growth had dipped below 100,000 in July. Over the past four months, however, the average monthly gain has been over 200,000. And the 203,000 job gains in November, along with the drop in the unemployment rate to a five-year low of 7.0 percent, should give the central bank a huge confidence boost.

Economists expect the momentum to continue into next year, with nonfarm payrolls averaging a 190,000 jump during the first quarter of 2014, rising to an average of 208,000 in the final three months of the year, the Reuters poll found. The jobless rate is seen averaging 6.6 percent in the fourth quarter of next year, before dropping to an average of 6.5 percent – the level that Fed officials have said would trigger discussions over when to raise interest rates from near zero -- in the first three months of 2015.

A brighter employment picture has encouraged Americans to loosen their purse strings again. October real personal spending rose by 0.3 percent -- the strongest reading in 12 months. Moreover, November retail sales rose 0.7 percent -- the best gain in five months.

Auto sales were particularly strong last month. The industry’s annual sales pace reached 16.41 million vehicles in November, the best monthly showing since February 2007, according to industry research firm Autodata.

All of these data appear to show consumers, which drive almost 70 percent of growth, are gaining confidence in the economy. It seems that the U.S. is close to a self-sustaining cycle of more jobs leading to more demand, and more demand leading to higher employment.

Furthermore, the risk of another government shutdown has receded. The Fed held fire on deciding to begin reducing asset buying after a bitter partisan battle in Washington that led to a 16-day partial government shutdown and brought the country to the edge of a debt default in October.

The House of Representatives in a bipartisan 332-94 vote Dec. 12 passed a $1.01 trillion budget plan whose main accomplishment is easing $63 billion in automatic spending cuts, the sequester, over two years. The Senate will begin considering it Tuesday.

The Case For Waiting

While the Bipartisan Budget Act of 2013 is the first bipartisan budget to pass the House in four years and it “takes the risk of a government shutdown off the table,” the deal “does not address the debt ceiling or expiring unemployment benefits,” IHS Global Insight U.S. Economists Paul Edelstein and Doug Handler said in a note.

The federal-sponsored Emergency Unemployment Compensation program, created in 2008, is set to expire at year’s end.

Discussions on these benefits could still take place in January, but if these benefits are not extended, the financial status of 1.3 million people will change. “They will either get jobs, drop out of the labor force, or become significantly less solvent,” Barclays’ Michael Gapen said in a note.

Finally, continued low inflation may bother some Fed officials enough that they want to delay tapering.

“For me, you don't have to be in a hurry [to taper] because of low inflation,” St. Louis Federal Reserve President James Bullard told CNBC television on Nov. 4.

Bullard voted in favor of maintaining the central bank’s easy-money policy at the October FOMC meeting. He wants to see inflation heading back toward policy-makers' 2 percent goal before tapering bond buying. Currently, inflation has been running much closer to 1 percent.

“Low inflation probably causes a still-cautious Fed to await more evidence that recent gains in the labor market and consumption can be sustained while also avoiding any action that could derail the holiday shopping season,” UBS’ Harris said.

What To Expect On Wednesday

For the statement, economists expect some acknowledgment of both the better labor market data and the stubbornly low inflation rate. The Fed could also note that downside risks, particularly from fiscal policy, have decreased.

FOMC members will also update their economic projections and they will likely paint a rosier picture.

Additionally, Bernanke will probably give a strong signal that tapering is imminent at his final press conference as Fed chair. He could also drop hints on how the Fed may attempt to minimize the impact of the tapering decision.