The Fed has enough ammo to taper: Trader

Ben Bernanke
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Ben Bernanke

One might have argued that the September Federal Open Market Committee meeting was one of the most surprising and important in quite a while, but prior to the meeting, the Federal Reserve actually did lay out the requisites for tapering — Wall Street just didn't pay attention. Instead, traders imposed a bias that the Fed ignored, and therefore we should expect the Fed to continue to ignore the bias of Wall Street.

If that is true, prudently, we MUST look at what prevented the FOMC from tapering last time.

Of course the front-and-center data point is the employment report, which not only was delayed as a result of the government shutdown, but it also came in lighter than the expectations of analysts on the Street. This is absolutely important data, but Fed policy makers never said that they needed to see strong data, they just wanted to see a stable trend, and that is why the trend was not a focal point at the September meeting. Terminology was definitely used suggesting that the Fed wait for additional data to taper, but the trend of the employment data was absolutely not a rationale for not tapering.

In fact, my observations based on Labor Department data suggests that the trend in employment has been solid, trending higher even though it may be at a more moderate pace than some would like, and that is what the Fed has wanted to see. The rationale for not tapering in September came from something else, and it is that we must respect going into this next meeting.

Specifically, the culprit was interest rates. The interest rate on the 10-year note had spiked going into the meeting, it was pressing 3 percent and they had been one-sided up (bonds were declining) since early May. There was no pause: Interest rates were surging going into the FOMC meeting, and Fed governors made it clear that they did not like the level of interest rates and could not justify tapering given where interest rates were and the trajectory of Interest rates accordingly. Piggy-backing on the already higher rate environment was not supported by the governors.

However, since then the trajectory of interest rates has changed, and the 10-year note is closer to 2.4 percent than 3 percent, so there is a nice gap and ample wiggle room now, something that did not exist in the September meeting. This is a green light to raise rates, but now there is the government shutdown to contend with. The question is, will they think the shutdown will have had long-lasting impact.

Clearly, investors do not believe so, and although some data may come in choppy, I doubt the FOMC thinks the shutdown will have long-lasting impact. If that is true, and they focus more on the recent trajectory of employment (steadily higher although at a moderate pace) and the level of interest rates, things that they have said before are important, we just might see a taper when the Fed issues its statement.

I know this would surprise everyone but almost everyone got it wrong last time, too. They even suckered me into changing my tone right before the meeting, because I was calling for NO TAPERING up until the final few days when I became convinced by the Street. Today I am again of the notion that the FOMC actually has enough to taper again, and this time, interest rates are not bumping up against 3 percent.

The rationale for not tapering in September definitely was the level of interest rates, the FOMC minutes prove it, and I think the Street again is overlooking what the FOMC has said. They are transferring their all-clear bias on equities to favorable FOMC decisions and fueling the rally, but the Street was wrong last time, they can be wrong this time, and if the FOMC discounts the impact of the shutdown like the Street is doing they will be left with a positive trajectory in employment and lower interest rates than last time, two things they have focused on and talked about as leading catalysts to taper.

Our eyes are on the 2x short long term Treasury ETF and we believe TBT may soon become a good buy, but it is not quite there yet.

— By Thomas H. Kee, Jr.

Thomas H. Kee, Jr. is president and CEO of Stock Traders Daily and founder of The Investment Rate. Follow him on Twitter @marketcycles.