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Beltway Perspective with Elliot Eisenberg
While Q4 GDP growth will probably be about 2.4%, slightly above the average rate of growth since the end of the Great Recession, it would be very surprising if the Federal Reserve Board (the Fed) were to begin reducing its monthly purchases of $45 billion in Treasuries and $40 billion in mortgage backed securities anytime soon.
While there are many reasons why, the most potent is that the mere suggestion last June that tapering might commence as early as mid-September rattled markets enough to raise interest rates on 30-year home mortgages by close to one-and-a-half percent in a matter of weeks, and in the process stop forward progress in the housing market dead in its tracks. The housing market is crucial to the recovery because with auto sales and manufacturing activity having all but returned to pre-recession levels, construction activity in general and its biggest component, new single family residential activity, is the last large cyclical sector not fully participating in the economic recovery. To have a self-sustaining recovery it is essential for all cyclical sectors to be at or near full capacity or rapidly moving in that direction.
In addition to a flat housing market, the labor market is showing signs of slowing down. During the first quarter of 2013 job creation averaged 207,000/month, while it was 182,000/month in the second quarter but just 143,000/month in the third quarter. Worse, while the unemployment rate has been steadily falling since the end of the Great Recession, it has been primarily thanks to the steady decline in the labor force participation (LFPR) rate from 65.5% at the end of the recession to just 63.2% today, the first time ever that the LFPR has declined after the end of a recession.
The above notwithstanding, the economy is really recovering. Household deleveraging is almost over, manufacturing and transportation activity have recovered to pre-recession levels, banks are once again healthy, corporate and household balance sheets have recovered and employment is almost back to where it was before the recession began. Given how far the economy has come, I think the Fed would prefer to essentially “buy” some downside economic insurance by continuing their current level of Treasury and MBS purchases.
Something that would change my prediction will be the success or failure of the congressional budget negotiations that were part of the deal to end the two week government closure. Lawmakers have a deadline of December 13th to produce a budget blueprint that will drive government spending for FY2014. The deadline is just days before the Fed’s last meeting of the year. A congressional deal would give the Fed some clarity on the fiscal front, and undoubtedly hasten the date of the first taper. On the other hand, negotiations that end in stalemate would increase fiscal uncertainty and reduce government spending by leaving sequestration in place, thereby reducing GDP growth.
In short, the economy is currently growing, but slowly. As a result, the labor force participation rate continues to decline, employment growth is weak, and due to poor Fed communication about interest rates, the all-important housing market has stopped growing.
For all these reasons, the Fed may give lip service to the idea of commencing tapering following its mid-December meeting, but any tapering is more likely to start after its end of January meeting, and most likely following the Fed’s mid-March meeting, the first in 2014 to be followed by a press conference. And remember, short term rates will remain at their current rock bottom levels for another 18 months.
Elliot Eisenberg, Ph.D. is President of GraphsandLaughs, LLC and can be reached at Elliot@graphsandlaughs.net.
His daily 70 word economics and policy blog can be seen at www.econ70.com.