Testing times in the tapering camp

The mere mention of a tapering of the Fed’s bond-buying program sends the market into convulsions. Two sources rule in the search for a signal.

Forget Hayek versus Keynes. Forget even Krugman versus Reinhart-Rogoff. 

There’s a new economic showdown in town, this time between US Federal Reserve watchers Robin Harding and Jon Hilsenrath.

These are the new names reverberating around financial markets as traders frantically look for clues as to when the Federal Reserve will begin withdrawing its monetary stimulus program. Harding caused a sell off last night after his column titled “Fed likely to signal tapering move is close” hit screens. Traders paranoid about a tapering of the Fed's $US85 billion a month bond-buying program pushed the sell button, although shares later recovered. 

So just who are Harding and Hilsenrath and why are they moving markets? 

Robin Harding is the US economics editor for the Financial Times. A Brit, Harding has been living in Washington for three years. He is a former Tokyo correspondent for the FT. He studied economics at Cambridge before graduating with a bachelor of arts, economics in 2000. 

In the apparently opposing corner is another young gun, Joe Hilsenrath, perhaps the most keenly watched Fed watcher, until last night at least.

Hilsenrath is the chief economics correspondent for The Wall Street Journal, also based in Washington. A New York native, Hilsenrath has a bachelor’s degree from Duke University and masters in journalism from Columbia.

His article released late last week lead to a rally in shares after its title “Fed likely to push back on market expectations of rate increase” hit screens.

What did it have to say that was so drastically different to Harding’s article last month?

Well not too much. 

The funny thing about the Hilsenrath versus Harding debate is that both men essentially agree with each other. The central case of both is that the US Federal Reserve will begin to “taper” its monthly $US85 billion per month bond-buying program in coming months, probably in September and probably to around $US60 or $US65 billion a month.

A somewhat bemused Harding took to twitter last night amid the market sell off saying: “Glad people are reading my Fed preview. I’ve been in the September taper camp for a while and I’d stick with that”.

This was followed shortly by another tweet: “But people need to chill out. The Fed does not leak anything to any journalist to steer markets – especially during blackout.” (The Australian Reserve Bank has introduced a similar blackout period where it will not speak to journalists one week before board meetings).

Hilsenrath's column last week made a similar point to Harding's last night: that the US Federal Reserve needs to communicate more clearly that any tapering of its asset purchase program does not necessarily mean rate rises around the corner.

Concerns about tapering have led markets to also pull forward their expectation of rate hikes. Bond yields have risen as traders expect rate hikes to come as soon as next year.

Both Harding and Hilsenrath make the point that this is misguided. The Fed is committed to a rule, publicly stated last December, that it will keep short term interest rates near zero until the jobless rate reaches 6.5 per cent or inflation rises faster than 2.5 per cent. The job market is not expected to hit that point until 2015.

It is this nexus – between tapering and rate hikes – that Fed Chairman Ben Bernanke must break in his post meeting press conference later this week.

US monetary policy remains heavily stimulatory. And tapering is not nearly the same thing as turning the hose off – just turning down the flow. Even if the Fed buys $US65 billion of assets a month, rather than $US85 billion, this is still stimulatory.

Conceivably, the Fed could turn the tap down to $US65 billion, but keep it on for longer, meaning it would, over time, purchase more bonds than if it kept the hose on at $US85 billion but for a shorter period.

Neither of those options implies anything about when the Fed will take the next step, which is to raise interest rates from close to zero currently.

Both Harding and Hilsenrath agree that the taper is coming. But the point both men are making is that the time between the taper and any rate rises could be long. And this timing will be entirely determined by the already stated rule that rates won’t rise until the jobless rate falls to 6.5 per cent.

Skittish markets are displaying all the rationality of a cocaine addict scared his dealer will soon cut their supply. And that's despite assurances from the dealer that it will keep dealing, albeit smaller amounts. 

Weening the market's monetary stimulus addicts could prove more difficult than the Fed first thought.