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Ahead of Wall Street

Friday, May 24, 2013

The Fed has put the market on notice that it is seriously thinking of reducing the level of accommodation it has been providing lately. The debate within in the Fed appears to be about ‘when’ instead of ‘if’ it should happen.

The most reasonable takeaway from all of this is that if the economy continues to improve and doesn’t show any notable signs of weakness in the coming weeks, then we can expect the taper decision to come as soon as the Fed’s June meeting. This is not the consensus view, as most investors expect the decision to come later this fall or early next year. But the possibility of the taper announcement coming soon can’t entirely be ruled out anymore.

Market participants use terms like ‘hawks’ and ‘doves’ for those on the Fed’s policy-making committee that are for or against the tapering decision. We know the identities of these ‘doves’ and ‘hawks’ and what their concerns are. The ‘doves’, which includes Chairman Bernanke, appreciates that the economy is improving, but they are concerned that recent fiscal changes like the payroll tax hike and budget sequester could be problematic for the economy. Knowing this provides investors a useful framework through which to look at all incoming economic data going forward.

What this means is that the data doesn’t need to show a lot of strength; it just needs to avoid the onset of weakness. If there is no evidence of fresh weakness in the data, then it improves the odds of the taper decision. Using this simplified framework, this morning’s April Durable Goods report favors the taper decision, with both the 'headline' and 'core' components coming in better than expected.

We are unlikely to see major moves in the stock market in today’s session. But the overall tone will likely be on the weak side ahead of the long weekend. Overnight markets out of Japan improved from the day before, but they still remained fairly volatile.

Sheraz Mian
Director of Research


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