April 30, 2014 / 9:11 PM / 4 years ago

COLUMN-Fed tapers, pity about the data: James Saft

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

April 30 (Reuters) - The Fed charged ahead with its taper Wednesday; pity about all the evidence.

I don’t usually like to quote from FOMC statements, which are designed to be boring, but check this out:

“Information received since the Federal Open Market Committee met in March indicates that growth in economic activity has picked up recently”

I know this world is all about ‘what have you done for me lately?’ but this is just silly.

Growth has picked up in April, perhaps, but that’s after it was almost nothing, literally, in the first three months of the year.

Wednesday we learned that growth in the economy in the first quarter was only 0.1 percent, and that was courtesy of a huge increase in health spending. If you zero out health, the economy actually contracted by about 1 percent last quarter.

So the Fed saying economic activity has picked up recently is a bit like a man whose house was hit by a tornado yesterday saying his housing has improved recently because they put boards over the windows today.

In both cases the weather may have improved, but in both cases we still face considerable difficulties.

And yet still the Fed tapers.

The Fed also noted that the housing recovery, which is usually a key leading indicator of the economic cycle, remained slow.

I’ll say it’s slow.

Residential investment actually made a negative contribution to GDP in Q1 for the second consecutive quarter, meaning it was a drag on growth.

One consequence of the taper is that as of now the Fed only buys $20 billion of mortgage-backed securities per month, along with $25 billion of Treasuries. Given that 30-year mortgage rates, now at 4.3 percent, are up 73 basis point in a year, this can’t be helpful for mortgage originations or housing investment.

That’s a real tightening, and we might reasonably expect mortgage interest rates to be lower, and potentially investment higher, if it were not the case.

Now, to be sure, the economy was slowed by bad weather in the first quarter, and so we might expect some bounce-back. But blaming residential investment’s slump, two quarters of it, on cold weather in January in New York is to ignore Sacramento and Las Vegas. It also ignores the real impediment to household creation: decent jobs and decent wages.

It isn’t so much that I am arguing that QE can fix all of that, but rather that we ought to acknowledge that the Fed is getting out of the bond-buying business despite all of that.


Yes, there are parts of the economy which are reasonably strong, notably consumer confidence and spending, but the labor market is still very weak and inflation is no threat. That’s all consistent with 0.1 percent growth but not, on its face, with the taper.

So, why is the Fed so eager to back away from QE? First off, it is important to acknowledge that there is no single answer to that: the FOMC encompasses a variety of opinions and the dividing lines are more muddied than simply ‘hawks’ and ‘doves’.

It is likely, at least in part, that the desire to end bond buying comes out of an analysis of its risks and benefits. While it is surely stimulative, the distribution of QE’s benefits are uneven, and concentrated in those closest to the point of financial intermediation.

As well, there are the risks which bond buying potentially builds up within credit markets: namely bubbles.

Jeremy Stein, who is leaving the Fed at the end of May, suggested that where there is a conflict between financial stability and the bank's dual mandate it should perhaps err on the side of financial stability. (here)

That’s different from saying credit markets are now in bubble territory, which he did not, but it is a meaningful way of looking at the central bank’s decisions given the apparent conflict between sluggish growth, low inflation and cutting back on a stimulative policy.

For now the Fed seems to be choosing stability, perhaps because, unlike growth, stability may actually be achievable. (At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft) (Editing by James Dalgleish)

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