Using data provided directly by the Treasury we can quantify the influence of the current stimulus program and determine how much wiggle room the Federal Reserve has now to taper its bond buying program.
This analysis begins with an assessment of the influence of the current program with definitions that allow us to project the influence next year as well.
The purpose of infusing capital into the economy is to improve economic conditions, prevent deflationary risks, and initially to stabilize financial markets.
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With the ultimate goal of allowing the economy to grow on its own eventually, current stimulus measures have worked to improve asset prices, but underlying macroeconomic conditions suggest that the velocity of money that might normally increase along with aggressive stimulus like what we have seen recently does not exist.
Stimulus efforts like what we are witness to now can either influence the economy by purely infusing capital into the system or by increasing the velocity of money within the system. But because the velocity of money in our current environment is so low we can reasonably conclude that the main influence of the current FOMC stimulus policy is to infuse capital.
Therefore, identifying the actual capital infusions into the financial system is critical when quantifying the effect of tapering.
According to my assessments, which are based on a combination of Treasury action and FOMC stimulus, with adjustments for foreign interest in Treasury bonds, the domestic net stimulus from our current $85 billion monthly bond-buying program is only about $16 billion per month.
Review of the equation below to extrapolate this detail.
FOMC stimulus -((Treasury Issuance - refunding) X (foreign interest inverse multiplier))
Given the equation above, the current $85 billion monthly capital infusions into the financial system of the United States is offset by $68.91 billion per month in domestic treasury operations.
Our current factor for foreign interest is 15 percent, but foreign interest in U.S. treasury bonds has been declining steadily from recent highs near 30 percent.
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Although foreign interest in U.S. Treasury bonds could remain immediately weak, my assessments also suggest that foreign interest should increase going forward. I am expecting foreign interest of 20 percent or more in calendar 2014.
An adjustment for foreign interest is one difference between the current influence of monetary stimulus and our evaluation of the future influence of monetary stimulus, the second being the reduced funding demands indicated by the U.S. Treasury for 2014.
According to the Department of the Treasury funding requirements decline by 23 percent in calendar 2014 from what they were in 2013, and as a result the U.S. Treasury expects to issue far fewer bonds in 2014 than it did in 2013. This is a critical component in a major influence in this assessment.
Given these adjustments for 2014, the equation above suggests that if the FOMC continued with their $85 billion monthly capital infusion, instead of infusing $16 billion per month into the US economy, it would be infusing $35.4 billion per month given the reduced demand indicated by the Department of the treasury.
If the FOMC continues on its current pace without tapering its bond buying program it will actually increase real net stimulus by $19.4 billion per month.
This quantified observation offers three real conclusions: the first is that the current $85 billion monthly program will become much more stimulative if nothing changes.
The second is that the FOMC could taper by about $20 billion without changing the real net stimulus to the US economy.
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And the third, the FOMC could taper by $35.4 billion before the combined efforts of the U.S. Treasury and Federal Reserve become a drain on liquidity.
In summary, not only is the FOMC highly unlikely to taper its bond buying program given the economic mandates imposed by Ben Bernanke and the support for those mandates that the governors offered, but also whenever tapering actually begins the Federal Reserve has a tremendous amount of wiggle room given the reduced funding requirements indicated by the Department of the Treasury.
These observations serve to suggest that the fear of tapering is overhyped and we expect this fear to be reversed out of the market going forward.
This will not change our earnings assessments or our macroeconomic assessments, but it does play a material role in market sentiment.
—Thomas H Kee Jr. is president and CEO of Stock Traders Daily and author of Top of the Market to You!