Hilsenrath Dovish Strike vs the Charts

Record highs in the stock market, 6-year highs in US consumer sentiment, the longest streak of +100K NFP in 12 years, 6-year lows in unemployment rate, 2-year highs in bond yields. With these dynamics at play, the Fed ought to scale down monthly asset purchases, by at least $10 bn this year (even if it is symbolic) to account for the change in fundamentals over the last 6 months (and not the last 6 weeks). Failure to do so, is serious lapse of credibility to Bernanke and doves at the Fed.

Ahead of this week’s trifecta of major US events, Q2 GDP (Wed), FOMC decision (Wed) and jobs report (Fri), the debate on whether the Fed will start tapering this year should grow noisier just when Bernanke’s message appeared to have grown in clarity.

Hilsenrath track record?

WSJ reporter Jon Hilsenrath’s latest market-moving article was once again (dovish and USD-negative), suggesting the Fed will lower the unemployment threshold required before raising rates to below the current suggested threshold of 6.5%.

Recall, over a month ago, Hilsenrath again crushed the hawks when he said the Fed would likely push back market expectations of a rate hike. That dovish article was published 6 days before the June 19 FOMC, which ended up being unexpectedly hawkish, as Fed Chairman Bernanke for the first time suggested that tapering would start this year.

Two weeks later, the minutes of that same FOMC meeting elicited a dovish interpretation, revealing that most members wanted to see more evidence of macro improvement-particularly in labour markets-before tapering would begin.

Looking closely, markets are to blame. Traders are not distinguishing between the requirements for tapering and conditions for raising interest rates. The former, we were told by the Fed requires “more evidence that the projected acceleration in economic activity would occur before reducing the pace of asset purchases”, while higher interest rates require the decline in unemployment rate to near the 6.5%. Hilsenrath’s latest article suggests the Fed would want an unemployment threshold lower than 6.5%.

But reactions to conditions of higher rates are premature as any rate hike isn’t expected to occur until end of 2014 or even 2015. What matters now, is communicating the timing of tapering asset purchases and not higher rates. And as Bernanke has already reiterated is, the scaling down of asset purchases does not necessarily mean a tightening of policy as the Fed plans to maintain policy accommodation as needed and the balance sheet expanding.

The charts below illustrate record gains in US stock markets , 6-year highs in consumer sentiment, 6-year lows in unemployment and 2-year highs in bond yields. With these dynamics at play, the Fed ought to scale down monthly asset purchases, by at least $5 bn this year (even if it is symbolic) to account for the change in fundamentals over the last 6 months (and not the last 6 weeks).

One other thing to bear in mind:

Since Bernanke shall leave the central bank this year, he is highly unlikely to depart while keeping the asset purchasing program “as is” behind him. Failing to do so would label him as Greenspan Bubble Master #2,  starting the QE bubble without a plan to end it or even scaling it down.