Will the Fed Taper Wednesday?

By Jennifer SchonbergerThe FedFOXBusiness

It’s the multi-billion dollar question markets and economists have been asking all year: When will the Federal Reserve begin curtailing its bond purchases?

To answer this question we have to step back and look at the Fed’s original roadmap. The central bank’s plan called for unwinding its bond purchase program -- known as quantitative easing, or QE -- when the unemployment rate hit 7%. Well, we’re at 7% unemployment. Indeed, an increase in the number of jobs added in both October and November put the average pace of job growth just under 200,000 per month over the past 12 months.

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But here’s the problem: 7% unemployment isn’t necessarily 7% on its face. The so-called U6 unemployment rate tells the real story. That measure, which includes Americans who dropped out of the workforce because they’re discouraged, or are working part-time for economic reasons, stands at 13.2%.

Underscoring that, the labor participation rate is treading at levels last seen more than 30 years ago.

Aside from tepid job growth, a number of economists point to lower inflation than the Fed would prefer as a reason to table tapering. Remember, the Fed has two responsibilities: (1) to maintain full employment and (2) make sure there isn’t troubling levels of inflation or deflation. Of course, going back to the Fed’s original plan, near-zero overnight interest rates -- not QE -- are meant to target inflation.

Still, prices that businesses pay to make products have declined for a three straight months because of falling energy prices. More importantly, incomes adjusted for inflation are growing less than 1% this year on an annualized basis. That’s less than half the 50-year average income-growth rate of 3.25%. It’s also below already-slow growth so far in this 4.5-year anemic economic recovery.

Indeed, Federal Reserve Chair nominee Janet Yellen signaled at her confirmation hearing that it was “imperative” that stimulus not be withdrawn too soon -- perhaps implying the Fed is worried about deflation.

The last thing the Fed wants to do is pull back its stimulus only to have to reverse course. More likely, the Fed is happy to take an extra month or two before it begins curtailing its bond purchases to ensure the slow progress in the labor market is sustainable. What’s more, some of this data may be skewed because of the government shutdown. And, although lawmakers struck a bipartisan tone in passing a budget for the next two years, they’ve yet to deal with raising the nation’s borrowing limit, which will come due in February.

Bottom line: while no prediction is a slam dunk, the odds are the Fed will wait until early 2014 to taper.

What do you think?

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