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This time five weeks ago, markets were ready and waiting for the Federal Reserve to begin its "taper," the beginning of the end of its program of pumping billions of dollars into the economy by buying bonds.
Not only did Fed leaders elect to sit on their hands at that meeting; now the smart money thinks they won't even start to slow their bond buying until this coming spring! That's all the more remarkable given that there has been no radical shift in the tenor of economic data, just a series of mild disappointments, of which the September jobs report issued Tuesday morning was the latest example.
After peaking at 1.88 percent in August, the yield on a five year U.S. treasury bond is down to 1.29 percent Tuesday — a hint that investors expect the Fed to keep buying bonds and putting downward pressure on rates. On Sept. 17, futures markets priced in a 46 percent chance that the Fed would increase its short-term interest rate target by the end of 2014. Those odds were down to 21 percent Tuesday.
Here is Michael Feroli, chief U.S. economist at JPMorgan, describing his assessment in a new report to clients: "Absent some miraculous improvement in the data, tapering in 2013 now looks to be off the table. The 2014 calendar gets tricky. If our economic forecast were realized, we'd expect a first tapering at the March meeting. However, the date of the March meeting is right around when we expect the next 'drop dead' date on the debt ceiling. Given this, our modal view on the first tapering is now April."
So what's driving this? Three big reasons stand out.
What had seemed like a soft patch in the labor market is increasingly looking like downshift in the pace of growth. In the first six months of the year, job growth was just under 200,000, which is about the level some Fed officials have spoken of as the threshold for the "substantial improvement" in the labor market they want to see before ending quantitative easing policies. In the past three months, job growth has averaged only 143,000.
As Feroli suggested, that doesn't count as "substantial improvement," ergo Fed leaders will likely be inclined to hold off on tapering their bond buying until they see it.
Fiscal policy is looking like more of a drag on growth than the Fed and other forecasters had expected as recently as September. The impact of sequester spending cuts and tax increases has already been factored into projections. But now there is the risk that the government shutdown and debt ceiling standoff will have knock-on effects by damaging consumer and business confidence.
We don't know whether, or how much, the October drama will affect the overall economy. We know even less about what sort of debt standoff might loom this coming winter. But the risks these events create are almost all on the downside. As long as that's the case, the Fed is going to be inclined to be more cautious about withdrawing its stimulus.
It's now official: Janet Yellen is President Obama's nominee to take over as Fed chair when Ben Bernanke's term is up Jan. 31. While she still has a confirmation process to get through, her imprint will likely influence the Fed's decisions even before then. One imagines that her voice — already influential, in that she is the central banks' current vice-chair — will carry even more weight at upcoming meetings now that it is known she will be the next person in charge.
And that tends to tilt in a dovish direction. While Yellen and Bernanke have been basically on the same page on their policies, she has tended to lean in a slightly more dovish direction, which is to say worried about the job market and the consequences of ending easy money policies too soon. She has been less inclined to fret about the side effects of QE, such as stoking financial bubbles.
There is a lot we don't know about what sort of Fed chair she will be, and the president has some big decisions to make in the coming months as to who will surround Yellen at the board of governors (including who will replace her as the No. 2 official). But if one were to bet, it would be on her continuing easy money policies as long or longer than Bernanke would have.
Add it all up, and the forecasts that the taper will wait to spring and that easy money from the Fed will be here a while seem well-grounded.
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