By Ben Turney
Taper, taper, taper.
It’s all I seem to read about these days. The increasing sense of panic is palpable. But rather than running around like the headless chickens (or should that read “talking heads”?!), let’s step back for a moment and ask ourselves what might the taper mean?
I’ve been pretty bearish on US stocks for most of the summer. My first short trade did pretty well, but my latest one couldn’t have gone much better. As of writing I have actually closed it, as the market looks primed for a mild relief rally.
If this rally happens, I could well look for a chance to go short again, but I am conscious of the timescale from here.
Last month’s FOMC policy statement was something of a shock, in that no official word was given about plans for the taper. The release, yesterday, of the minutes of that meeting didn’t give definitive guidance that the taper is going to happen in September. I previously wrote that I thought it was going to, but I now suspect the Fed is going to wait and review the next lot of data before it acts.
The fact that Ben Bernanke has decided not to go to this year’s Jackson Hole meeting of global central bankers looks significant. This is the first time in 25 years that a Chairman of the Federal Reserve hasn’t attended. Back in 2010, Bernanke used Jackson Hole to inform the market that QE2 was on the way. Look back at the charts and you’ll see the QE2 rally started at pretty much exactly this point.
This year, however, the FOMC is faced with perhaps its toughest choice in a generation. This may sound a little dramatic and possibly even misplaced, given the extraordinary measures that have been taken over the last few years, but remember that most of those have been reactive decisions. Now the Federal Reserve has to make a series of complex and proactive actions. It has inflated a stock market bubble and, under no circumstances, can allow that to pop. It’s far from clear how they are going to do this, but I think we’re witnessing the monetary policy version of softly, softly catchy monkey.
In spite of some of the more hyperbolic commentary I’ve read today, last night’s minutes were pretty anodyne. They didn’t reveal what the Fed was going to do and simply confirmed the general commitment to tapering when the data allows. Even that guidance comes with all manner of caveats. Now, with Bernanke not at Jackson Hole, it looks like the Fed is trying to batten down the hatches as much as possible, to give it a clear run to mid-September’s meeting.
Although it is not clear exactly when the Fed will act, I believe this is all very telling about how they will act. The last two QE programmes had fairly definitive end dates, insofar as the Fed committed to purchasing specified amounts of bonds. The latest incarnation has been daubed “QE Infinity” because, although the Fed set a limit on its monthly purchases ($85billion), its commitment was open ended as ending the programme has always been data dependent.
However, what the Fed hasn’t ever said is over what period of time the taper will happen. The more I’ve thought about it, the more likely this could be a fantastic opportunity in the making. At present US stocks are getting hammered in anticipation of QE coming to an end. What if, though, the process of withdrawal is conducted over a longish period of time?
If you think about it, the Fed could string this process out almost indefinitely. Say, for the sake of argument, when they announce that the taper is about to start, it is quite possible they reduce purchases by a limited amount. For example, they could easily decide to reduce purchases by $10billion a month for three months, with a provision to keep assessing the economic response, before reducing any further. Were they to follow such a course of action then the reality of this would still mean $75billion a month of QE. More than enough to keep the rally nicely fuelled.
Of course I have pulled these figures out of thin air, but I’m just attempting to illustrate the point. The taper might well not be as abrupt or absolute as many currently seem to expect.
For now I am staying out of this market, but over the next few weeks I might buy weakness or sell strength. As ever it all depends on the trading levels.