Waiting for Fed's Taper to Start? You May Have Missed It

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Jacquelyn Martin/APFederal Reserve Chairman Ben Bernanke.
By Jeff Cox

Investors avidly awaiting signs that the Federal Reserve is ready to reduce its monthly stimulus may find that the news already has passed them by.

Tapering, as the market calls it, easily has been the market's main concern, and in fact only worry other than sustaining the modest growth in both earnings and gross domestic product.

That worry began in May of this year when Fed Chairman Ben Bernanke first raised the prospect during a congressional hearing, and speculation over when it may start has been a major market-mover throughout.

The Fed has been creating $85 billion a month that it uses to buy Treasurys and mortgage-backed securities, expanding its balance sheet to just shy of $4 trillion, in what is known as quantitative easing, or QE. It also has kept its target funds rate near zero since the financial crisis hit in 2008.

There's reason to believe, though, that the reduction in the pace of monthly bond purchases -- and that's all it will be, a reduction, not a cessation -- already has been mostly priced into market action and may not have such a monumental impact as is feared.

"Tapering may be a concern, but there are reasons why it may not be as much of one as many expect," Citigroup (C) credit analysts said in a report for clients. "In fact, we have seen signs in recent trading that U.S. credit may be fairly immune to tapering headlines."

"Immune" may be a bit strong considering that the market almost always has some reaction to Fed statements, however benign or substantial.

But recent rate movement suggests that while yields may well go higher, %VIRTUAL-article-sponsoredlinks%the yield curve -- or the difference between rates of different maturities -- shows that the market may already have had its big reaction to tapering.

Almost immediately after Bernanke's initial tapering speech, the curve for investment-grade and the benchmark 10-year Treasury note jumped 0.8 percentage points while high yield rose 2.8 percentage points.

But the Citi team pointed out that spreads stayed stable during the most recent tapering scare as economic data improved in early December.

"One of our basic [tenets] is that the markets are efficient ... maybe not perfectly, but at least reasonably," Citi said. "In this regard, it's important not to forget that the QE tapering topic has been in the news for over six months."

There are also two significant facts worth remembering about tapering:

  1. The Fed has had ample supply for its operations since the government doubled the national debt over the past five years to more than $15 trillion. That is changing, though, with the lowest amount of debt issuance, at just over $2 trillion, a low since Lehman Brothers collapsed in September 2008.
  2. Government debt maturity is likely to be at its highest level ever at $1.4 trillion.
Investors, then, may want to look beyond the headlines and knee-jerk market reaction when weighing the true substance of QE reductions.

"QE is obviously a huge source of direct demand in the rates space, and a large indirect source elsewhere. All else equal when tapering takes place demand in the rates markets will fall sharply, and of course a spillover effect will be felt among risk assets," Citi said. "But all else is not equal."


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Waiting for Fed's Taper to Start? You May Have Missed It
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Teachers from kindergarten to high school are allowed to deduct up to $250 for money they spend buying supplies for their classrooms. This deduction's available even to those who don't itemize, making it more valuable than most deductions. According to figures from The Tax Institute at H&R Block, more than 3.6 million teachers took advantage of this provision in 2010 to deduct $915 million in expenses. This deduction has been extended regularly ever since its initially scheduled expiration in 2005, so, even though it's on the chopping block again, it's a pretty good bet that lawmakers will let the tax break survive into 2014.
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Congress commonly waits until late in the year to extend expiring tax provisions like these, as well as others not mentioned above, such as the exemption for charitable IRA distributions, deductions for mortgage insurance premiums, and the higher immediate write-off amounts for small-business equipment purchases.

Lawmakers often use what's known as a tax-extenders bill to pass all the extensions in a single package. Earlier this month, WOTC Coalition President Paul Suplizio said that a seemingly unrelated Medicare-payments bill was probably the first step toward a year-end tax extenders bill that would cover expiring tax breaks like these.

And, just as millions of Americans procrastinate until April 15 to file their taxes, we can expect lawmakers to wait until Dec. 31 -- or beyond -- to decide the fate of these tax breaks.
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