The Pre-Taper Economy

With taper talk in full gear, it seems like a good opportunity to take a look at where we have come since we began QE3. QE3 started in September of 2012 and then was expanded in December. For the entire year, so far, of 2013, the Fed has been buying $85 billion in MBS and Treasury securities.

The idea on why the Fed should begin tapering, from the media’s perspective, is that the economy has seen employment improve and inflation returning, thus a need to cut tapering. Every employment number and inflation data set is heavily scrutinized as an indicator to what the Fed will do in their meeting next week.

In September of 2012, non-farm payrolls (for August) advanced by 165,000. On Friday, we saw that non-farm payrolls advanced (in August) by 169,000. Through August of 2012, the U.S. had added 1.429 million jobs. So far this year, through August, we have added 1.442 million jobs. Not the drastic improvement in the job market some may assume.

Inflation is another key indicator to determine the future policy of the Fed. When we began easing in September of 2012, we had seen CPI (YoY) at 1.7% and the July reading currently shows CPI of 2% (the August reading will be released when the Fed begins its two day meeting on the 17th).

GDP has improved slightly from the reading we had when QE3 began. In September 2012, 2Q GDP was at 1.2% on an annualized basis. Currently, 2Q GDP is showing 2.5% annualized growth. But even as we continue to debate the reasoning of tapering, we can see that the economic data that is so heavily scrutinized by investors really isn’t that much better.

The easing program has lifted asset values as the S&P 500 has moved from 1440 at the end of September 2012 to currently at 1655. Some may argue that this inflation of asset prices is a negative impact of QE and thus current stock prices are artificially inflated. But companies have been able to show an ability to grow, to some extent, their top lines (S&P 500 companies grew their top lines in Q2 by 1.4%) and valuations seem to suggest companies are not too rich at the current time. Thus, QE likely gave companies an ability (or greater comfort) to take risks, which was needed after such a shock to the marketplace.

But despite the minimal changes in employment and inflation, the economy seems stable enough to stand without easing. Vehicle sales continue to improve, housing is beginning to pick up, retail sales are stable and GDP has improved.

It does not seem that the Fed is tapering because of drastic improvements in employment or because of worries that hyperinflation is right around the corner. Rather, it must be that they feel the need of easing has been drastically reduced and the risks to further easing (at these levels) are greater than the benefits.

They have no desire to move rates in the near future and this is what should be beneficial to corporations and economic growth. The ability to access credit at low levels and invest in an improving economy will continue to be the most beneficial aspect of Fed policy.

(All data used within The Capital Course was provided by Ned Davis Research)