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11 Jun 2013

Stalled jobs may delay US taper

Kevin Logan

by Kevin Logan

Chief US Economist, HSBC

Brooklyn, New York

Federal Reserve Chairman Ben Bernanke has emphasised that any reduction in QE would be gradual

The US economy has been sending out mixed signals. The housing market, for example, is in a strong uptrend but the manufacturing sector is beginning to falter. This has fuelled uncertainty about the US economic outlook, including among members of the Federal Open Market Committee (FOMC), which appears to be considering tapering or slowing the pace of quantitative easing (QE), possibly towards the end of 2013.

When the FOMC launched the current QE3 programme of quantitative easing in September 2012, it said the expansion of its balance sheet would continue until the outlook for the labour market improved substantially.

The housing market is in a strong uptrend but the manufacturing sector is beginning to falter

Now unexpected developments in the labour market may be influencing the thinking among FOMC members about the appropriate timing for adjustments in the QE programme. In particular, reported job gains for 2012 have been revised higher and this year’s gains have been generally stronger than expected.

For us, the FOMC’s criterion of a “substantial” improvement in labour market conditions translated into at least a 1 per cent six-month gain in payroll employment that lasted for several months. With total payroll employment close to 130 million jobs, that would imply an average monthly gain of about 220,000 new jobs.

Recent gains in payroll employment have been close to the 1 per cent six-month gain we have posted as a guiding criterion for QE this year. Tapering talk has emerged among Federal Reserve officials, who seem to be anticipating “real and sustainable” improvements in the labour market outlook that could allow them to start gradually scaling back the programme over the next several months.

We are not confident that the next few months will show sustained improvements in the labour market. We expect GDP growth to slow from the first-quarter reading of 2.4 per cent. We think job gains could falter and thus expect the FOMC to delay any cuts in the QE programme until December 2013.

Cutbacks in federal government spending began in March and are becoming more of a drag on economic activity. Leading indicators suggest growth in overall demand is starting to slow. And we expect that inflation, already well below the Fed’s medium-term goal of 2 per cent, will remain low throughout 2013.

We think job gains will falter and thus expect the FOMC to delay any cuts to the QE programme until December.

Fed Chairman Ben Bernanke has emphasised that any reduction in QE would be gradual. He has also tried to convey the message that any move to reduce the scale of QE would not necessarily be the start of a pre-determined series of steps to end the programme.

The FOMC wants to retain flexibility on QE. This means the scale of QE would be changed as much as the Fed funds rate is changed, either up or down in response to economic and financial market developments.

But the active discussion among FOMC members about adjusting QE in response to improving labour-market conditions raises not only the question of when a reduction might start, but also the size of the first reduction in the current USD85 billion a month programme. And there is also the question of how gradual the reduction in monthly purchases will be once it starts.

Fed officials have given few hints and there is clearly disagreement among FOMC members about how to proceed. Some policymakers would like to move quickly once they start to reduce, while others prefer a more gradual pace.

Our current expectation is that the Fed continues the current USD85 billion QE programme until December 2013 then announces a cut in monthly purchases by USD25 billion to USD30 billion from January, followed by another USD25 billion or USD30 billion at the start of the second quarter, before reducing the programme to zero by the end of June 2014.

Purchases in the QE3 programme totalled USD568 billion in its first nine months. If the FOMC follows our expected policy sequence, the additional purchases might add up to between USD860 billion and USD900 billion, making a total of around USD1,450 billion.

This research was first published on 5 June 2013.
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