Fed tapering sooner - Does it matter?

All the Fed talk and investor buzz has been about tapering, but the discussion should be divided into two parts: one, the signaling of future monetary policy as either being hawkish or dovish, and two, the impact on credit expansion and economic activity. The economic impact of a tapering may be minimal. The signaling issue of bringing an end to QE and sooner increases in rates can be consequential for financial markets, less so for real markets. 

It could be argued that with the significant amount of reverse repo, excess money is being drained from the system and thus offsetting Fed purchases. There are technical and curve components to the reverse repo activity, but there are just excess funds without a home at a current level of approximately $800 billion a day.

Another way of thinking about the limited impact of QE in the current environment is to look at the difference between the monetary base and reserves. The difference has had remained constant for the last year. While liquidity was needed in March, it is less clear whether it is necessary to support the bank lending channel now. The issue is now centered on whether there are good investment projects not whether there are funds available. 

With mortgage rates at five-month lows and housing prices reaching highs, there is even less reason for the Fed to be purchasing mortgages. A scaled reduction will not impact economic activity and provide some rationality to the MBS market. Fiscal policy and regulation will have more impact on sustaining economic growth than more money from the Fed. 

The signaling that the Fed will provide less liquidity yet is not tightening is a different issue. Perhaps the reflation trade was overdone, but wording and signaling on intention with respect to inflation will have a greater impact on forward expectations. There may be an immediate negative reaction to tapering, but for the real economy and loan activity, it will be a non-issue. Pushing forward Fed rate increases will have a very different and negative impact.

The Fed would like to walk a fine line and start tapering but assuring markets that low rates will continue.