Weighing U.S. Fiscal and Monetary Policy

fisisiAfter Friday’s better than expected October employment report showing 204,000 non-farm payroll jobs added to the U.S. economy, economists are divided about forecasting the month the central bank will begin to taper their $85 billion monthly quantitative easing program.

The Fed’s monthly purchases of $45 billion in U.S. Treasury and $40 billion in mortgage-security bonds that began in 2012 has helped to propel U.S. stocks to record highs while pushing mortgage rates lower and accelerating the economic recovery in the United States.

In May and June Federal Reserve Chairman Ben Bernanke began to talk about the Federal Reserve possibly reducing the pace of their quantitative easing program (QE3 ) as the employment outlook showed real signs of steady improvement.

Bernanke’s “taper talk” caused major ripples in the market and became one of the driving catalysts for the yield on the 10 yr. Treasury moving 1 percentage point higher in only 3 months (May-July), resulting in mortgage rates also jumping 1 percentage point and pressuring the  recovering housing market.

Many economists were expecting the Federal Reserve to announce some form of tapering with their quantitative easing program during the Fed’s September policy meeting, just ahead of the October fiscal debates in Washington D.C. since a September taper was already “priced in” with U.S. treasuries.

But Fed Committee members decided against tapering in September and made it clear in their September policy statement that downside risks remain in the economy while inflation is still well below their 2 percent target range.

Fed members also acknowledged the sudden jump in U.S. interest rates since May arose from “shifting expectations” regarding their own monetary policy with quantitative easing.

“The move in interest rates appeared to be importantly influenced by shifting expectations about monetary policy” Fed members wrote in their statement.

Fed members also expressed some legitimate caution about the fiscal drag and the economic fallout from the fiscal debates which culminated in a 16 day federal government partial shutdown in early October, short- term budget resolutions for keeping the government funded through January 15th and lifting the debt limit through Feb. 7th while creating a bi-partisan budget committee to work out a longer term budget plan before their new December 13th deadline.

In the Fed’s most recent October policy statement, there was no mention of risks to the economy from the sudden rise with interest rates since the spring and Committee members were quick to point out that “the downside risks to the outlook for the economy and the labor market have diminished since last fall.”

Committee members cited “growing underlying strength in the broader economy” along with improvements in labor market conditions and economic activity.

“Taking into account the extent of federal fiscal retrenchment over the past year, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program as consistent with growing underlying strength in the broader economy” the Fed wrote.

Some economists took note of the shift in tone with the Fed’s outlook and moved up their forecasts of an earlier December taper with the Fed’s quantitative easing program, even despite the fiscal uncertainty on the horizon in early 2014 due to the short-term budget resolution deadlines in January and February along with the major leadership transition in the Federal Reserve with Janet Yellen replacing Chairman Ben Bernanke.

Other economists such as Jan Hatzius, chief economist at Goldman Sachs, believe that the Fed’s taper won’t begin until March when the entire transition in Fed leadership is behind us, he admitted yesterday on CNBC’s Squawk on the Street.

“I also think that they will combine the tapering with a shift in forward guidance and our baseline would be March” Hatzius said.

Budget Committee

The budget committee led by Senator Patty Murray (D-Wash) and Rep. Paul Ryan (R-Wisconsin) will meet again tomorrow on November 13th to find a long term budget resolution that could beecome an alternative to the “across the board” sequester cuts.

Republicans in the budget committee are pushing for wider entitlement cuts while Democrats are seeking to end corporate loopholes.  Some type of fiscal agreement is expected to be approved by the budget committee by their self imposed Dec 13th deadline or else January 15th.

Next Fed Meeting

Committee members from the Fed Reserve will meet next on December 17-18th.

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