With exactly one week to go before the next FOMC announcement, the two most important considerations for the Federal Reserve should be the outlook for the economy and the potential reaction in the financial markets. However there is one additional factor that could affect their decision to taper or not taper before the end of the year and that is Bernanke’s legacy. There is no question in our minds that the man who has served as the head of the U.S. central bank for the past 7 years is thinking about whether he wants to end his legacy being known as the person who halted the Santa Claus rally or worse, the Grinch who stole Christmas.
The increased odds of December tapering have already weighed on equities, which struggled to extend higher after Friday’s blow out non-farm payrolls report. While the S&P 500 is still within striking distance of record highs and the pullback in USD/JPY over the past 48 hours is indicative of nothing more than profit taking, if the Fed tapers next week, unless it is nothing more than a benign symbolic move, stocks could come crashing down. The holidays are always a sensitive time for the economy and financial markets as it is the final opportunity for U.S. companies to attract a burst of revenue and end the year in the green. Anything that could threaten this progress would be counterproductive for the overall economy especially given the vulnerability of the current recovery.
With this in mind, we took a look at how many times the Federal Reserve tightened monetary policy in the month of December and found that over the past 30 years, the central bank changed interest rates 13 times before the holidays and only 4 of those moves was to raise rates. They tightened monetary policy in 2005, 2004, 1988 and 1986. With the exception of 1986, the increase in interest rates was consistent with a long period of tightening that started well before the December meeting and continued well into the next year. In 1986, the rate hike was the first of a series of moves. This study suggests that while the central bank has no qualms about loosening monetary policy before the holidays, they are much more reluctant to tighten it.
Of course, the current level of monetary stimulus is different from anything that we have seen in the past and unprecedented times could call for unprecedented measures. Even if the Fed chooses to reduce stimulus this month, it still leaves monetary policy extremely accommodative. So while history suggests that the central bank will prefer to wait until after the holidays to reduce monthly bond buys, knowing that they are delaying the inevitable, December tapering is still on the table.