Strange trading action in the euro recently (possibly signifying a re-emergence of systemic concerns or the sprouting of new geopolitical issues and concerns), the somewhat sketchy nature of recent Chinese growth data (in that the numbers are improving, but are we really to believe them?), the sticky jobs situation, and very modest nature of the economic growth here in the US all provide plenty of justification for the Fed to be very careful about the implementation of any tapering plans.
Factor in the additional concerns over the US’s involvement in Syria and the specter of a nasty budget battle in Washington and one could easily make the argument that the Fed should not do anything right now to upset the apple cart.
One more small issue: As someone commented to me over the weekend, “Who’s big enough to take the other side of the trade on an aggressive tapering program? The Fed is
the market.” While the point is, as I’m sure Bernanke himself would scream, debatable, it is nonetheless thought-provoking. I mean, even if you were big enough to take the other side of the trade -- and few are -- why would you? The countries who can make that trade are not our buddies right now, so becoming more indebted to them would only be beneficial to them if they were betting on rates dropping or staying flat. Do we really want those entities hoping that things get dicey enough over here that rates drop, and having enough strings to pull to make that come to fruition? I mean, we’re probably already there in that respect, but why allow ourselves to get deeper into that situation?
So why is the market still pricing in tapering?
All that being noted, here are, in my humble opinion, the key fundamental, economic, and procedural points that traders and analysts must process when considering tapering.
Bernanke is rumored to have a verbal agreement with his more hawkish colleagues that tapering will start in September. This rumor has been out there for weeks, before Friday’s crummy jobs report, but also before the stream of positive data that occurred for the weeks leading up to Friday.
Technicals in favor of tapering:
Bernanke will be leaving his post soon. Common sense and more chatter tells us that he will not let the new chairman have the implementation of tapering -- and whatever ramifications that may carry with it -- be their first order of business. Plus, it would likely leave Bernanke feeling that he left his post with a grade of incomplete if he doesn’t at least oversee the beginning of the unwind of the massive stimulus that he helped start.
DXY technical strength: The DXY’s failure to break down on Friday’s weak US jobs report is the most recent and obvious piece of evidence. The DXY finished above the midpoint of the day’s trading range Friday, which technicians saw as bullish considering the negative news. Now today’s a different story; the DXY is taking a stab at short-term “correction support” at 81.68 (it was at 81.84 as of 11:10 a.m. ET). But until the greenback closes below that support level, the bullish / taper-in-September case remains unblemished from a technical perspective.
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10-Year Treasury note yield technical strength: The same bullish (by virtue of failing to post a bearish candle Friday given the news) action can be seen in the TNX’s daily chart. Just as with the DXY, however, yields are down this morning and are likely to test out “correction support” at 2.826%. Any break and close below that level or below 81.68 on the DXY will change things in this analyst’s mind.
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All that being noted, there are plenty of reasons not to press the brakes at all, and Bernanke does not want to be known as the bad guy who sent the economy back into a tailspin, so anything the Fed starts in September will likely be just on the other side of symbolic.
Technicals in favor of "tapering light" or no tapering at all:
The equity markets’ refusal to really crumble recently -- modest pullbacks notwithstanding -- is a big sign that institutional investors either don’t believe that the Fed will taper at all or that it will very gently ease its way into its efforts to return to normalcy. Given the fact that yields and the DXY are not tumbling precipitously, the chances of no tapering at all in September would seem to be minimal, so we’re left with “tapering light."
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As noted, all of this points to a very modest tapering effort beginning in September -- if one begins at all. There is no indication in the facts or the rumors that the Fed’s tapering will be overzealous in nature. Let’s put it this way: When considering the law of unintended consequences, the Fed had better not be overzealous!
No positions in stocks mentioned.
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