REUTERS/Jason Reed
U.S.
This is something that Fed Chairman Ben Bernanke and his peers have been talking about since May.
The decision to taper is tied to the Fed's economic expectations, which Fed-watchers believe allow for the taper to begin in September. As such, Fed-watchers also warn that the Fed risks losing credibility if it decides not to taper.
However, Morgan Stanley's Matthew Hornbach thinks its a mistake to consider credibility when forecasting Fed policy.
If FOMC Meetings Always Went as Expected…
…they would not be very important events to markets globally. So critically analyzing market expectations helps to expose risk scenarios. In the case of tapering, the most common rationale used to explain why the Fed will taper in September deals with Fed credibility. Given the market expects the Fed to taper in September and the Fed has yet to push back in a meaningful way, not tapering would cause investors to lose faith in future Fed communications and create undue volatility.
We find this logic flawed. The Fed does not pander to market expectations. And Fed pushback against market expectations does not only occur in between FOMC meetings. Finally, the Fed has shown its willingness to accept near-term market volatility (that may result if it chooses not to taper) if it will help avoid even higher volatility in the future.
In our view, markets may interpret a delayed tapering as a signal to a more prolonged purchase plan, and react accordingly. While the Fed might value an additional six or twelve weeks given the current downtrend in payroll data, the market may interpret the decision differently. Delaying tapering - relative to market expectations - could change the debate back to 'why taper', as opposed to 'why not taper', and create a large market reaction...
So, don't be surprised if Bernanke throws the market a curveball next Wednesday.