It appears the plethora of talking heads discussing the FOMC's potential decision to 'Taper' - and the subsequent sell-offs in a number of risk-assets - believe this action has stemmed from better economic data (as the 'manipulated' unemployment rate has drifted faerie-like towards their target - but don't call it a threshold [5]). However, as Barclays notes and we have been warning, there is another interpretation that is more worrisome for the market - that is a change in the Fed's 'reaction function'. As is clear from the minutes of the latest FOMC meeting, there is a growing concern over bubbles, technical dislocations, and the cost-benefits of a QE program out of control. The market's reaction to these two reasons for 'tapering' will be significantly different and reading the Fed tea-leaves even more critical than ever.
[6]
Reaction function #1 - the consensus view...
[7]
The serial extrapolators at the Fed perhaps see the chart above and therefore - a Taper is on the cards...
But we know (and therefore we assume the Fed knows) that this 'target' is predicated on a conceptually broken data item that shows little to no improvement in reality [5]
[8]
and inflation expectations (and realized) have been sliding notably...
[9]
And away from pure unemployment - the economic data is anything but improving...
[10]
so is it:
Reaction Function #2 - costs/benefits analysis is becoming skewed...
[11]
So - it's not just about the 'taper' decision but what is driving them to this decision. As asset-gatherers bluster about the fact that the Fed can't leave now because things are not that great (correctly) they are perhaps missing the key point that the Fed has changed its reaction function from fundamentals to technicals - and is worried...
Charts: Bloomberg and Barclays