Is Anybody Listening? A Reminder of Why Taper is Kind of a Big Deal (we forgot too)
In 2006 BC (Before the Crash) a musical was staged that contained both American Idol contestant Adam Lambert and our least favorite Batman – Val Kilmer. Kilmer starred as Moses and Lambert as Joshua (one of the 11 or 12 brothers). While Pharaoh continued to enslave Joshua (Lambert) and his family he sings a song entitled is “Anybody Listening.” While we are not fans of Broadway – and Kilmer’s Moses does us no further favors in terms of endearing us to the musical form – the idea that no one is listening seems the kind of sentiment that marks today’s activities.
So because you’ve become comfortably numb, to use a more favorable musical metaphor, we think a quick refresher as to what may or may not be at stake is worth some time.
Here’s a quick checklist for tomorrow afternoon to remind us: why are we concerned about the “taper”?
1) Fed Balance sheet expansion
The expansion of money supply through the near trebling of the Federal Reserve’s balance sheet has risen more than a few hackles over the post-crisis period. When initially announced, it had the intended effect of lowering all points along the yield curve re-stimulating the housing market that had only recently been given more than a 50/50 chance of survival.
While all seemed relieved to not have the entire financial system collapse the major milestone that was touched in episode one of this Fed adventure was the neat idea that one part of the government could create debt and another part of the government could buy that debt. Many people understand the un-cool part of cannibalism, but when you’re hungry and it’s the only thing around…
2) The relationship between and correlation to asset price reflation
Interestingly, the Fed made no bones about this part of its strategy with the Fed Chief himself pointing out on numerous occasions that his policies were, in part, able to put stock market valuations back to or close to new highs.
While observationally true the question investors have asked is, “At what cost?” This too seems to be a question at the Fed.
In Bernanke’s Aug 2012 speech at Jackson Hole, he laid out what he thought the costs were:
a) The first possible cost of conducting additional Long Term Asset Purchases (LSAPs) is
that these operations could impair the functioning of securities markets.
So far there seems no issue here especially as it pertains to the Treasury markets. In fact, given yesterday’s CPI numbers we think the bid for Treasury securities is robust enough to keep us at these levels (and possibly lower) for some time to come.
b) A potential cost of additional securities purchases is that substantial further expansions
of the balance sheet could reduce public confidence in the Fed’s ability to exit smoothly
from its accommodative policies at the appropriate time.
We now understand more clearly why the communication protocol during the spring and summer was so strident – they were doing a dress rehearsal for 2014. The operational issue at play in concern number two was how the idea of “public confidence” erosion would manifest itself. While we have seen a fair amount of front running the bond markets, we haven’t seen any substantial impact on the broader economy or, perhaps more importantly, the labor markets. The one market that was directly affected was housing – we will touch on that in moment.
c) A third cost to be weighed is that of risks to financial stability. For example, some
observers have raised concerns that, by driving longer-term yields lower, nontraditional
policies could induce an imprudent reach for yield by some investors and thereby threaten
This is now a real issue for a number of reasons – not the least of which is illustrated by the chart below.
Interestingly, the net effect in terms of the stability issue comes more from Dodd-Frank banking and Basil 3 regulations rather than emanating from the Fed in any material fashion.
How do you say “liquidity crisis”?
d) A fourth potential cost of balance sheet policies is the possibility that the Federal Reserve could incur financial losses should interest rates rise to an unexpected extent.
I think we all know that the Fed can eat the losses – this was never a material concern of anyone. (Wow – two-cannibalism references in one piece!)
3) The impact that the taper may have on employment
While GDP and corporate profits seemed to continue moving along at a reasonable pace during taper’s dry run, we know that the Fed continued to be confounded not only by the current jobless rates but by the labor market’s complexion. We still see too many part time workers for economic reasons to feel that the labor markets are anything close the robustness that Bernanke, Evans, et al. would like to see ahead of a major shift in direction – which is what taper will be.
While GDP and corporate profits seemed to continue moving along at a reasonable pace during taper’s dry run, we know that the Fed continued to be confounded not only by the current jobless rates but by the labor market’s complexion. We still see too many part time workers for economic reasons to feel that the labor markets are anything close the robustness that Bernanke, Evans et al would like to see ahead of a major shift in direction – which is what taper will be.
4) The shape and condition of the housing market
Buoyed by the lowest and longest period of available 30 year financing, the US housing market appears to be on a path to recovery. We’ve long thought this recovery was a mirage in the desert.
Recent talks with major lending institutions still dealing with the foreclosure conundrum suggests that they are still very much in the middle innings which in turn makes us more convinced than ever that the inventory issue is the lynchpin of the recent steady climb in home prices. We know for sure it’s not a rise in wages.
It is important to remember that it was the housing market that found itself the most vulnerable to this summer’s dry run of taper. 2014, to our mind, will be no different.
If you forgot why today matters, you’ve been reminded. There are risks, the Fed understands them, feels like it has control of them and we think balks at the idea of laying taper with a bow at the holiday party that the market seems to be having at the moment.
Q1 is always a sobering time for markets, investors and so why not leave the bah-humbug until then?
One thing is for certain, 2014 will be a very different year than 2013.
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