QE Tapering Preview: 5 Reasons, 6 Scenarios and 7 Potential Currency Reactions

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The Federal Reserve convenes for a highly anticipated meeting to make a decision about QE tapering. There is a a very high probability that the Fed will announce a reduction in the pace of bond buying on September 18th, and probably by $10-15 billion to $70-75 billion.

Here are 5 reasons for the expected tapering, 6 scenarios for the decision and the all-important accompanying statement, and the potential reactions of 7 different currencies, some are weaker and some are stronger.

The statement and economic projections will be released at 18:00 GMT, and Bernanke will face the press at 18:30 GMT.

5 reasons why the Fed will taper

  1. Ongoing recovery: Despite the recent weak employment report, the US is still growing and creating jobs. Jobless claims are edging lower and PMIs show an intent to hire. This recovery isn’t that strong, but at this point, the effectiveness of bond buying is limited in creating a “wealth effect” that Bernanke mentioned.
  2. Fear of inflating bubbles: Bernanke and co. can look at QE and see it as a success story in the housing market, with a clear recovery. However, with house prices rising around 12% YoY (Case Shiller), perhaps the time has come to reduce the level of stimulus (the Fed doesn’t see tapering as tightening) to avoid blowing a bubble. In addition, the Fed might worry about other bubbles in stocks, commodities and emerging markets.
  3. Thick hints: The notion that the “Septaper” is coming is strengthened by recent comments from Fed officials, that come with “an open mind” to tapering in September. This includes the doves. With the Syrian issue somewhat defused, there are very little chances that the Fed will not taper.
  4. Legacy: We now know that Summers will NOT inherit Bernanke. Even if Bernanke stays on the job and doesn’t evacuate his chair for Janet Yellen, he would probably like to begin unwinding the biggest monetary stimulus in history and not leave it as a hot potato.
  5. Passing the ball to the government: the Fed would prefer that the government pick the baton and provide address the sequester. They already criticized the government for lack of short term stimulus and talked about things that are out of their realm.

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Deutsche Bank: "Yellen May Actually Have To Increase QE" - Here's Why

With what few vacuum tube-based trading algos are left and reacting with rabid kneejerkiness to every flashing red headline, one would get the impression that what matters to the Fed's decision on how to adjust its balance sheet flow depends on the US economy. But if Deutsche Bank is correct, the next source of global economic contraction, which it will be up to the Fed to offset (just like China was the marginal growth dynamo in the months after Lehman filed), and result in an increase in QE nevermind taper, is not in the US at all, but in China where things are about to go bump in the night. Which means that just like that we have moved into the "New Normal paradigm" where the worse the news out of China, the better for stocks.

From Deutsche's Jim Reid:

Over the weekend, China’s inflation, industrial production and retail sales numbers for the month of October will be released. China’s much awaited Third Plenum meeting gets underway tomorrow where DB’s Jun Ma expects a wide ranging package of reforms will follow, in terms of industry deregulation, financial liberalisation, reforms to land titles, state-owned enterprises and social security. Our take on this is that there will be lots for the market to get excited about in the reforms but that it will not necessarily be easy to implement them successfully. Our GEM equity strategist JP Smith yesterday reiterated his bearish view on China and most of the EM complex. If he's correct Yellen and Draghi are going to have interesting 2014s with the provocative thought being that Yellen may actually have to increase QE. Food for thought.

And just for thought, because very soon the bulk of the world's population won't be able to afford any other kind. Especially once the Fed is forced to start monetizing Big Macs.

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They will not taper. By now the QE is the main driving force of US economy and they are trapped by it

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