Saturday, September 14

Cheap money or not, the Fed can't win

Cheap money or not, the Fed can't win
| By Anthony Mirhaydari, MSN Money

Whether the Federal Reserve decides to ‘taper’ its money-printing on Sept. 18 or wait until later, the market will take a hit. It’s best to watch from the sidelines.

With the threat of an airstrike on Syria diminishing, investors are preoccupied by the next great market catalyst: The Federal Reserve's big announcement on Sept. 18.

Everyone wants to know whether or not Bernanke and company will pull back on the money printing -- tapering, to use the Wall Street term, the $85 billion-a-month bond-purchase program that started last September.

This stimulus program is the third round of quantitative easing we've seen since 2008. And like the end of the first two rounds, it's being treated like a life-or-death decision by the cheap-money junkies on Wall Street. Seriously. Life or death.

Yes, this stimulus helped us get through rough patches, including the European debt crisis, the so-called fiscal cliff debate in Washington at the end of last year and the sequester budget cutbacks. Those have given way to some very positive signs of economic reacceleration, especially in manufacturing.

But regular folks could be forgiven for wondering why the taper would have to happen now. Job growth has slowed, as the labor participation rates plummets. Housing has cooled, as interest rates have soared back to early 2011 levels on expectations of Fed tapering. Inflation is relatively benign right now. And we've got another budget battle brewing in Washington.

With expectations all over the map, the Fed has done a terrible job of managing sentiment heading into its announcement. That raises the risk of a negative market reaction that could rattle confidence and short-circuit the improvement we've seen. But efforts to ease the pain might set us up for big problems down the road.

Here's a look at the situation and what investors need to look out for.

The most immediate problem with all this right now -- setting aside the broader discussions of whether the Fed should be playing such a prominent role in the economy and the markets, as well as whether it kept monetary policy too loose for too long -- is that since Chairman Ben Bernanke first started dropping hints about a taper in May, the messaging has been muddled.

That's created a will-they-or-won't-they guessing game of financial uncertainty. Investors and traders have scoured every Fed policy statement and every set of meeting minutes released by the Fed since then, looking for any morsel of information that could clarify the outlook.

It hasn't helped that the economic data has been a little uneven, with strong purchasing manager reports (globally, not just here at home) but soft data on payrolls (labor participation down to 1978 levels as people leave the workforce) and new home sales (down to October 2012 levels).

The basic idea is that improving data will lead to tapering, while weak data will not -- which in a sense makes bad news good on Wall Street and good news bad.

And while, overall, Wall Street expects a taper of $10 billion next week and an outright end to stimulus next June, there is wide variation around the numbers and timing. For example, Bank of America Merrill Lynch analysts don't expect any action by the Fed next week, believing instead that action will wait until the Fed's October meeting, and maybe until December. Yet Societe Generale not only expects a September taper but believes QE3 will wrap up as early as March.

Anthony Mirhaydari

Credit Suisse has an interesting outlook, penciling in a $20 billion cut to the bond-buying program. That's double the consensus estimate, which they think is necessary given less Treasury bond issuance (due to smaller federal deficits) and fewer mortgage originations (as the refinancing boom ends). With less supply, the Fed's demand for these bonds risks distorting the Treasury and mortgage bond markets.

But they also don't believe the taper will be on cruise control. Instead, they're looking for Bernanke to emphasize at the post-announcement press conference that taper decisions are data-dependent and that the $20 billion taper might be the only one for a while -- diminishing expectations of additional cuts later this year.

Given the wide range of expected outcomes, many are sure to be taken by surprise. Most of all, regular working folks still struggling in this economy.

That's because while the unemployment rate recently fell to 7.3%, its lowest level since December 2008, the decline was driven by a 312,000-worker contraction in the labor force.

That left just 58.6% of the population officially in a job. The quality of new jobs continues to be low, as it has since the recession ended in 2009. UBS economist Maury Harris notes that recent job growth has been faster in low-wage positions than in high-wage ones on a scale not seen since 2010.

Overall, the economy added 169,000 jobs last month, bringing the six-month average monthly gain to just 160,000. Given that we're still 1.9 million jobs from the prerecession employment peak (and even more when we adjust for the growth in the population), it'll be a long climb back at the current rate.

Now, the numbers shouldn't be like this.

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