StanChart's Fed tapering call postponed to June 2014, sees $20-billion reduction

We see a US$20-billion reduction in the monthly bond-buying programme (affecting both US Treasuries and mortgage-backed securities evenly), which will be followed by subsequent reductions of $20 billion at each meeting of the Federal Open Market Committee. In other words, we think the Federal Reserve will be patient before it tapers. We do not see an earlier small, symbolic taper. But when it does start tapering, the FOMC should relatively quickly bring down the bond-buying volume to zero. 

Our June taper call is supported by three main factors. 

The fragile economic backdrop. We now expect growth in the United States gross domestic product in the first half of 2014 to be more subdued than previously anticipated. Meanwhile, the uptrend in inflation may be more gradual. Job growth could stay tepid for longer. We see the trend in payrolls remaining around the 180,000-200,000 level for several months before accelerating more meaningfully by midyear as GDP growth picks up. 

We have lowered our 2014 US GDP forecast to 2.4 per cent (from 2.8 per cent) and 2015 forecast to 2.8 per cent (from 3.0 per cent). Consumer spending remains the biggest contributor to the US economy. We expect consumer spending to remain subdued near-term. We see two particular structural factors restraining household spending growth: the still-fragile job market and ongoing household deleveraging. 

Government spending is the second-largest contributor to US GDP. We forecast public spending to contract by 2.1 per cent this year and 1.0 per cent in 2014. The federal government has begun a long and arduous process of budget cuts. 

Investment is the third-largest component. Investment growth should be driven by a continued uptick in the housing sector and an expected pick-up in corporate investment. Net exports tend to be a drag on growth given the current-account deficit. We forecast a neutral contribution to GDP in 2014.

A subtle underlying change in the Fed’s stance on QE. The burden of proof is now with forward guidance rather than QE as debates shift to forward guidance’s ability to be as effective as QE. Behind September’s FOMC decision was a resurrection of the perception of QE as an effective tool, in our view. 

Janet Yellen. We think that the FOMC’s centre of gravity will remain dovish under Yellen’s leadership – despite the arithmetically rising prominence of the hawks due to the rotation of regional Fed presidents and the reshuffle among Fed governors. 

September’s no-taper decision and its results will probably continue to guide the Fed’s action next year. We think the change will evolve slowly; the October statement was still very neutral, containing an explicit taper bias. Recent Fed speeches have been more nuanced than the October statement.

Overall, it is now clear to us that the Fed needs to buttress its case significantly for tapering, and this will include clearer communication on the thresholds needed to taper; more evidence that growth, and to a lesser degree inflation, is about to accelerate; and a reinforcement of the forward-guidance policy. 

This supports our view that QE tapering is unlikely before June.

 

_Danny Suwanapruti is a senior rates strategist for Standard Chartered Bank, based in Singapore. Daniel Tenegauzer is head of US research, based in New York.