The U.S. Federal Reserve will begin to wind down its quantitative easing program, perhaps as early as this year. But investors should not expect Fed chairman Ben Bernanke to start that process until December. So says Peter Buchanan, senior economist at CIBC World Markets.
“They are going to move,” Buchanan told me in an interview on Monday. “I think the message they’re going to give [today] is that they’re not quite at that point yet.”
A bit of background: On May 22, Bernanke rattled investors when, during a question-and-answer session, he said the Fed would begin to wind down its US $85 billion-a-month bond-buying program sometime “in the next several meetings.” By meetings he was referring to regularly scheduled Fed retreats, at which Bernanke delivers a prepared statement and takes questions from the media.
This was a surprise. Everyone knows the Fed will stop buying bonds (as a means of keeping interest rates low) eventually. But when? Was Bernanke signaling that the move might come earlier than expected?
“What people really didn’t pay much attention to was that this was contingent on a fairly upbeat economic backdrop,” Buchanan told me. “We do think the U.S. economy will pick up over the next few quarters. But to date, the data is lukewarm.”
For example, we learned earlier this month that the Institute for Supply Management index — a key indicator of the state of U.S. manufacturing – posted its worst result in four years in May. The index dropped to 49%, from 50.7% the previous month. A result below 50% means more manufacturing companies are shrinking rather than growing.
On the other hand, a new inflation report out yesterday gave investors reason for optimism. The consumer price index ticked up 0.1% after two months of negative reports from the U.S. Department of Labor. The core index, which excludes food and energy costs and is therefore a good representation of general pricing movements, is up 1.7% for the year ending in May. This all points to improving consumer demand.
“The consumer seems to be bearing up quite well,” said Buchanan. “The housing recovery is still picking up. Unfortunately, the goods sector does not look quite as strong as it did a couple of quarters ago.”
Buchanan said there is a growing consensus that the Fed will begin its wind-down in the fourth quarter of this year. “Probably more likely December than early in the quarter,” he told me. “I think [Bernanke] is going to emphasize that it’s very much dependent on the economy as well.”
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