Four Reasons the Fed Shouldn’t Taper Just Yet

Economic growth slowed in the first half of 2013 and there are signs that the second half will not see as much growth as economists originally expected. With inflation subdued and rising mortgage rates hurting the housing market, September is shaping up to be a difficult month for the financial markets.

By Steven Russolillo
2:45 pm Aug 27, 2013
Wall Street Journal

In our previous post we laid out the reasons why the Fed should start tapering in September. But that’s far from a done deal, for a number of reasons.

Economic growth slowed in the first half of the year and there’s signs that the second half won’t be as rosy as some economists expect. Inflation is subdued, rising mortgage rates are starting to crimp the housing market and September is shaping up to be a difficult month for the financial markets.

In our second post on the subject, MoneyBeat lays out four reasons the Fed should not start tapering its asset purchases at next month’s meeting. And be sure to check the counter arguments in our previous post.

INFLATION

One half of the Fed’s “dual mandate” says the central bank should strive for price stability. In the past, the Fed has tightened monetary policy to keep inflation in check.

Now, not only are inflation expectations low, but they’re well below the central bank’s target rate of 2%. The Fed’s preferred measure of inflation has been ranging around a historically low 1% annual gain. While most officials expect it to rise, they’ve been repeatedly surprised at the weakness of price pressures.

Last week, St. Louis Fed President James Bullard said it’s hard to understand why the Fed would pull back on its bond-buying program when inflation is so far below the Fed’s official target. ”I’ve been saying that I don’t think we have to be any hurry to taper given the data configuration we face,” Mr. Bullard said in Jackson Hole, Wyo. “We can afford to be patient.”

As long as inflation remains subdued, there’s no need to rush to pull the punch bowl.

RISING INTEREST RATES

The bond market’s era of easy gains came to an end in May when Fed Chairman Ben Bernanke acknowledged a change in policy could happen later this year. Since then, the benchmark 10-year Treasury yield has jumped from 1.6% to 2.95% last week, a huge move for the Treasury market.

The move has caused a spike in interest rates, something the Fed has been trying to prevent amid all of its accommodative policies. The impact has been felt in the housing market, where the rate for a 30-year, fixed-rate mortgage stands at about 4.6%, up from 3.59% two months ago.

The rise in rates has trickled down into the housing market. Sales of new-home sales slumped 13.4% in July, the steepest drop in three years.

Rising rates have taken place before the Fed has even made a move on its stimulus. Once it actually starts curtailing its asset-purchase programs, the move in interest rates may be even more severe than what’s taking place now.

ECONOMY STILL STRUGGLING

The economy is far from firing on all cylinders. The looming shift in Fed policy is taking a toll on the increasingly fragile housing recovery, as seen by last week’s housing data. Then came Monday’s report on durable goods, which showed orders tumbled 7.3% last month, far worse than economists forecasted.

GDP growth clocked in at a 1.4% rate in the first half of the year and there are worries that a strong second-half recovery won’t materialize. Wal-Mart Stores Inc. warned earlier this month of the struggling consumer and the retail sector, in general, is going through some rough times.

More than four years after the recession officially came to an end, the economy still needs more stimulus.

SEPTEMBER WON’T BE PRETTY

The markets already will face plenty of headwinds in September. A taper announcement could make the month even more problematic. Budget debates over the debt ceiling, geopolitical risks stemming from Syria and Germany’s elections are expected to weigh on the markets.

Budget debates over the debt ceiling, geopolitical risks stemming from Syria and Germany’s elections are expected to wreak havoc on the markets.

The uncertainty surrounding the mid-month Fed meeting will only add to the proverbial wall of worry.

And on top of all that, September is historically the worst month of the year for stocks. The Dow has averaged a 0.9% drop in Septembers dating back to 1950, according to the Stock Trader’s Almanac. By comparison, the blue-chip average typically registers a 0.7% gain on any given month.

Given all that, why should the Fed pile on to September woes?

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