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Taper: Will They or Wouldn't They?

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Wednesday, December 18, 2013

It’s all about the Fed today, with the central bank’s Taper decision expected to be a close one. They didn’t make the call two months back when they were widely expected to do just that, but positive economic data since then and the recent budget deal out of Washington has put the decision back in contention.

The markets will likely remain in a wait-and-see mode ahead of the afternoon announcement and subsequent Bernanke press conference. The positive Housing Starts and Permits data this morning will likely not have much resonance given the Fed spotlight. In-line with the favorable housing data, we got better than expected quarterly results from homebuilder Lennar (LEN - Free Report) this morning. The earnings release from FedEx (FDX - Free Report) was mixed, with the shipping giant coming short of quarterly EPS expectations, but raising guidance for the full year.

Given the saturation coverage that the Taper question has received since May when Bernanke first floated it, the actual Taper announcement, should it come later this afternoon, may not carry much surprises. That said, there are still a number of aspects of the decision that remain uncertain. The size and composition of the Taper matters – will they cut by the expected $10 billion to $15 billion that everyone has been expecting or more? Will they cut back on Treasury bond purchases, mortgage backed securities, or a combination of the two? A bigger Taper will be a negative surprise for the markets, but will actually be indicative of greater confidence within the FOMC about the economic outlook. On that front, we will also get today the FOMC members’ economic forecasts.

The Fed has been trying hard to explain that Taper didn’t mean tightening. To emphasize that point, they may update their long-term guidance by providing new thresholds for inflation and unemployment rate. The current guidance says that they wouldn’t think about raising rates till the unemployment rate stays above 6.5% and inflation remains below 2.5%. They could potentially provide the lower bound of their inflation range, to accommodate those that appear concerned about disinflationary trends. They could lower their unemployment rate target as well, something that Bernanke has touched upon in his public comments in the past. The Chairman’s press conference, his last in that capacity, will likely touch on most of these topics.

Sheraz Mian
Director of Research

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