Guessing the Fed’s next move

After Friday’s jobs gains, the speculation about the Federal Reserve Board ending the $85 billion a month bond-buying program picked up. Coverage began Friday and continued through the weekend about one of the economy’s most important stimulus plans.

Here’s the story from the Wall Street Journal:

Fed Chairman Ben Bernanke will have to build consensus among officials about how soon to pull back on a program that has been the center of market attention for months and whose effectiveness isn’t wholly clear. Many are getting more comfortable with starting a delicate process of winding the program down, though disagreements about timing and strategy could emerge, according to public comments and interviews with officials.

The Fed’s next policy meeting is Dec. 17-18 and a pullback, or tapering, is on the table, though some might want to wait until January or even later to see signs the recent strength in economic growth and hiring will be sustained. On Tuesday, officials go into a “blackout” period in which they stop speaking publicly and begin behind-the-scenes negotiations about what to do at the policy gathering.

One important consideration: Are investors prepared for a move? Talk of pulling back earlier this year jarred stock and credit markets. On Friday they seemed to take the prospect of a pullback in stride.

The Dow Jones Industrial Average leapt 198.69 points, or 1.3%, to 16020.20, the largest rise in seven weeks. Friday’s gain snapped a five-day losing streak and put stocks within striking distance of all-time highs. The yield on the 10-year Treasury note barely rose, another sign that financial markets weren’t rattled.

Bloomberg reported Saturday that after the jobs report the number of economists predicting the Fed would decrease purchases increased, indicating that many believe the economy is recovering:

The FOMC has pledged to keep buying bonds until the “outlook for the labor market has improved substantially.” The central bank’s so-called quantitative easing has pushed the Fed’s balance sheet close to $4 trillion this year with purchases of Treasury and mortgage-backed securities.

The payroll and unemployment numbers “are impressive in terms of a stronger economy and the need to exit QE,” Pacific Investment Management Co.’s Bill Gross said yesterday on Bloomberg Radio. He said the odds of a December taper are “at least 50-50 now.”

Other reports yesterday showed an improving labor market is boosting consumer confidence along with the spending that accounts for 70 percent of gross domestic product.

Household purchases climbed 0.3 percent in October after a 0.2 percent increase the prior month, according to Commerce Department figures. The median estimate in a Bloomberg survey of 73 economists called for a 0.2 percent rise.

The Thomson Reuters/University of Michigan preliminary December consumer sentiment index rose to 82.5, the highest in five months, from 75.1 in November. Economists forecast an increase to 76, according to the median estimate in a Bloomberg survey.

The Labor Department’s household survey showed more people were entering the labor force. The so-called participation rate rose to 63 percent in November, the first gain since June. A month earlier it fell to 62.8 percent, the lowest level since March 1978.

Reuters covered comments made by the head of the Federal Reserve Bank of Chicago saying tapering was on the table, but he would like to see more positive moves in the economy:

A top Federal Reserve official, who has been one of the most ardent supporters of the U.S. central bank’s bond-buying stimulus program, said he was open to curtailing the purchases this month, although he would prefer to wait.

The comments from Charles Evans, the president of the Federal Reserve Bank of Chicago, suggest a strong report on November jobs growth on Friday has brought the Fed closer to reducing its third round of quantitative easing, known as QE3.

U.S. nonfarm payrolls expanded by a greater-than-expected 203,000 jobs in November, with the unemployment rate dropping to a five-year low of 7 percent.

“I’ll be open-minded,” Evans said in an interview with Reuters Insider, when asked whether he would support trimming the Fed’s stimulus at its policy meeting on December 17-18.

“Everything else (being) equal, I would like to see a couple of months of good numbers. But this was improvement.”

The jobs data cheered Wall Street. The Standard & Poor’s 500 Index broke a five-day losing streak and ended Friday’s session with a gain of 1.12 percent gain. U.S. government bond prices were little changed.

MarketWatch took the contrary position, writing about the reasons the Fed may wait to stop tapering:

The Federal Reserve is likely to hold off on scaling back its bond-buying program in December, using the meeting to prepare the markets for a move early next year, economists said Friday in the wake of the strong November unemployment report.

“The odds are that they basically almost pre-announce at the December meeting and say if numbers continue to be strong a tapering will start very soon,” said Jim O’Sullivan, chief U.S. economist at High Frequency Economics. Tapering refers to scaling back bond purchases.

John Lonski, chief capital markets economist at Moody’s Analytics, agreed. “At a minimum, they will strongly hint that a taper will be announced at the January 2014 meeting,” Lonski said.

There will be some internal pressure at the U.S. central bank to move in December, noted Joel Naroff, president of Naroff Economic Advisors in Philadelphia. “The pro-tapering crew [at the Fed] will start yelling at the top of their lungs to start yesterday,” he said in a note to clients.

“But I suspect the [Federal Open Market Committee] will only indicate that if the solid data continue, the conditions will be in place to start taking the pedal off the metal,” Naroff added.

Naroff said he still expects the Fed to start to taper in March, “though a robust December report could provide the cover needed to start in January.”

While Fed officials go into lock-down before their meeting, investors will just have to wait to see what they decide and how others will react. It is likely going to be the most important decision they’ll make this year.