Stocks: No Easy Solution to Taper Puzzle

No data. No bellwether earnings. No movement, not much anyway.

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The S&P 500 fell 0.2% to 1,767.69, as Cliffs Natural Resources  (CLF) fell 4% to $26.27 on lower metal prices and NRG Energy (NRG) dropped 3.5% to $27.06 after it reported a profit of 37 cents, well below forecasts for 63 cents. The Dow Jones Industrial Average dipped 0.2% to 15,750.76, as taper talk hit Travelers (TRV), which fell 1.7% to $86.44, and Chevron (CVX), which dropped 0.9% to $120.

So what’s happening with the taper? Heck if I know. But Fed members are out letting their voices be heard. Federal Reserve Bank of Atlanta President Dennis Lockhart, for instance, told Bloomberg that he wants to see more inflation before tapering begins. Minneapolis Fed President Narayana Kocherlakota, meanwhile, wants to see unemployment hit 5.5% before lifting interest rates and warned of tapering too soon. Dallas Fed President Richard Fisher, however, issued his own warning to markets: Tapering can’t go on forever.

Jefferies’ Ward McCarthy and Thomas Simons don’t think the Fed’s decision will be an easy one. They write:

We think it is unlikely that the FOMC will be faced with an easy tapering decision at any of the FOMC meetings over the next year. First, this cycle has been characterized by a series of mini cycles of accelerating and decelerating activity. To date, "sustained" improvement in the labor market and overall economic activity has been fleeting. Second, this cycle has also been characterized by low inflation due to a trend of falling commodity prices that offsets rising service inflation. Commodity prices are determined in global markets in an environment of decelerating global growth. Furthermore, the growth of the US energy sector has increased downward pressure on global energy prices. Finally, this is an era of utterly inept fiscal policy that also conflicts with the Fed objectives of maximum employment and stable inflation.

Don’t expect a replay of this summer’s taper-talk selloff when the Fed does start curtailing its bond purchases, says Miller Tabak’s Andrew Wilkinson. He writes:

The big difference between the initial taper tantrum and today that we feel is evident now is investors' understanding that even if the Fed buys fewer bonds over time and slows the pace at which it expands its balance sheet, monetary tightening remains several years away. This ought to be a supportive feature for emerging currencies and will prove positive for global stocks as the transition takes place. But as we highlighted over the summer, investors first must wrestle with the onset of change in Fed policy. They have to feel what it might be like to live with a less accommodative Fed. Second time around and we think the damage will be far less harmful and shorter-lived to boot.

It should be so easy.