I spent a couple of days in New York last week seeing economists and academics. The US Treasury market had just seen a significant sell-off, with 10 year yields rising from 1.63% at the start of May, to over 2.2%, with much of the damage done by Bernanke’s surprise talk of QE tapering during the Q&A following his address to Congress’s Joint Economic Committee. US 30 year mortgage rates sold off in parallel, and are now around 4%, potentially damaging the housing recovery.
I came away with two main conclusions. Firstly, given the stuttering nature of the US growth recovery (and the second half of this year could be mediocre, thanks to some back-loading of fiscal cliff tightening) the case for a slowing of QE in the next few months is not at all strong. Economists point out that Bernanke’s prepared testimony to the JEC was very dovish and in no way suggested that tapering might happen this year. His Q&A response appears to have been a communication error, as evidenced by some rolling back over the last couple of days via well connected journalist Jon Hilsenrath in the Wall Street Journal. And secondly, whilst we all focus on the jobs data in the States and try to forecast the timing of hitting the 6.5% unemployment rate threshold, we might be taking our eyes off the Fed’s other concern, inflation. Having spiked higher in 2011/2012, thanks largely to higher commodity prices (cotton, oil), core inflation measures, and particularly the Fed’s preferred Core PCE Deflator statistic, are falling to around 1%. Wage growth is also weak. With inflation 1% below the target level, a Taylor Rule approach would see the Fed easing interest rates by 1.5%, not hiking or withdrawing monetary stimulus! And with rates at the zero bound and a cut impossible, unconventional monetary policy would have to take the strain. More, not less, QE might be more likely than any tapering.