Yellen, Yellen You Got Tapering on Your Mind*

I think the conventional wisdom that a Janet Yellen Fed will be super dovish and that it won't begin to taper until April 2014 at the earliest is wrong. Why? First I think she realizes that if she is going to be an effective Fed Chair, she will have to establish her credibility early in the game. She can do that by aggressively tapering with a commitment to a very low rate forward guidance program. This will give her instant credibility with respect to both inflation and employment. For those who argue that a weak economy early next year will delay tapering, they will have to answer the question if the large scale asset purchase program is so necessary, why isn't it working? And they won't have the benefit of the government shutdown excuse. Beside most of the econometric evidence suggest that forward guidance is far more effective than large scale asset purchases for the real, as opposed to the financial, economy. Sorry Wall Street.

Second, the more bonds the Fed buys the more difficult it will be to raise interest rates in the future. To be sure it is economically correct for the Fed to use increases in the interest rate it pays on reserves as a substitute for selling securities, but it will be very politically incorrect. Remember when the Fed starts raising interest rates on reserves the proceeds will go to Wells Fargo, JP Morgan Chase and Citicorp. Populists on the left and right will scream as Fed remittances to the treasury drop from an estimated $84 billion in 2015 to $17 billion in 2018.(See a recent Fed paper at http://www.federalreserve.gov/pubs/feds/2013/201301/revision/201301pap.pdf)

*- With apologies to Gary Puckett and the Union Gap http://www.youtube.com/watch?v=OStqA1ggso0