Tim Duy's Fed Watch

Tarullo on Monetary Policy and Financial Stability

Federal Reserve Governor Daniel Tarullo tackled the issue of financial stability in a speech that I think is well worth the time to read.  The starting point is that many lessons have been learned over the past two cycles, including the perils of ignoring financial stability issues.  But how should such concerns be incorporated into the policymaking process?  Tarullo:

While few today would take the pre-crisis view common among central bankers that financial stability should not be an explicit concern of monetary policy, there is considerable disagreement over--among other things--the weight that financial stability concerns should carry compared with traditional monetary policy goals of price stability and maximum employment.

Tarullo begins with a brief overview of the financial crisis and the Fed's response, declaring partial victory:

...while the recovery has been frustratingly slow and remains incomplete, there has been real progress, despite the fact that in the past couple of years a restrictive fiscal policy has been working at cross-purposes to monetary policy, and that balance sheet repair and financial strains in Europe have made it more difficult for the economy to muster much self-sustaining momentum.

As Tarullo notes, the Fed's actions have not come without backlash.  Of much focus is the size of the balance sheet, and the likelihood of unwinding the resulting liquidity should inflation rear its head.  Tarullo quickly dismisses this concern as no longer of major concern given the expansion of the Fed's toolkit.  He turns his attention toward bigger game:

The area of concern about recent monetary policy that I want to address at greater length relates to financial stability. The worry is that the actual extended period of low interest rates, along with expectations fostered by forward guidance of continued low rates, may be incentivizing financial market actors to take on additional risks to boost margins, thereby contributing to unsustainable increases in asset prices and a consequent buildup of systemic vulnerabilities. Indeed, in the years preceding the crisis, a few prescient observers swam against the tide of conventional wisdom to argue that a sustained period of low rates was inducing investors to "reach for yield" and thereby endangering the financial system.

Policymakers currently anticipate the Fed will hold interest rates near zero into 2015, followed by only a gradual path of tightening.  The concern is that such a long period of low rates will spawn an asset bubble, or bubbles, similar to the process that many feel fueled the housing boom last decade.  The eventual unwinding of any bubbles would likely be unpleasant.  But, presumably, the period of low rates occurred for a reason - to support economic activity.  Therein lies the conundrum for policymakers:

The very accommodative monetary policy that contributed to the restoration of financial stability could, if maintained long enough in the face of slow recovery in the real economy, eventually sow the seeds of renewed financial instability. Yet removal of accommodation could choke off the recovery just as it seems poised to gain at least a bit more momentum.

So how can the Federal Reserve protect against financial instability?  Tarullo here makes a point I think the Fed will frequently reiterate:

As a preliminary matter, it is important to note that incorporating financial stability considerations into monetary policy decisions need not imply the creation of an additional mandate for monetary policy. The potentially huge effect on price stability and employment associated with bouts of serious financial instability gives ample justification.

By addressing financial instability risks, they are attempting to minimize deviations in inflation and unemployment.  In effect, they might slow the pace of activity on the upside in return for minimizing the downside.  This, however, is easier said then done, as it is difficult to sell delaying progress on the real problems of low inflation and high unemployment to fight against a phantom downturn:

Of course, this preliminary observation underscores the fact that the identification of systemic risks, especially those based on the putative emergence of asset bubbles, is not a straightforward exercise. The eventual impact of the bursting of the pre-crisis housing bubble on financial stability went famously underdiagnosed by policymakers and many private analysts. But there would be considerable economic downside in reacting with policy measures each time a case could be made that a bubble was developing.

The Fed is actively paying attention to markets in the search for stability risks.  Tarullo reports the outcome of the Fed's new macroprudential efforts:

At present, our monitoring does find some evidence of increased duration and credit risk, but the increases appear relatively moderate to date--particularly at the largest banks and life insurers. Moreover, valuations for broad categories of assets such as real estate and corporate equities remain within historical norms, suggesting that valuation pressures, if present, are confined to narrower segments of assets. For example, valuations do appear stretched for farmland, although recent data are suggesting some slowing, and for the equity prices of some small technology firms.

No broad-based concerns such as the equity surge of the 1990s or the housing boom of the 2000s.  Just pockets of issues here and there.  That said, all is not perfect:

Still, there are areas where investors appear to have been very sanguine regarding certain types of exposure and modest in their demands for compensation to assume such risk. High-yield corporate bond and leveraged loan funds, for instance, have seen strong inflows, reflecting greater investor appetite for risky corporate credits, while underwriting standards have deteriorated, raising the possibility of large losses going forward.

Weak underwriting for risky, leveraged assets that investors seem eager to acquire for unusually little reward.  This is the kind of situation, especially with leveraged assets, that will repeatedly gain the Fed's attention going forward.  What action has the Fed taken?  Tarullo:

In these circumstances, it has to date seemed appropriate to rely on supervisory responses. For example, in the face of substantial growth in the volume of leveraged lending and the deterioration in underwriting standards, the Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation issued updated guidance on leverage lending in March 2013. This guidance outlined principles related to safe and sound leveraged lending activities, including the expectation that banks and thrifts originate leveraged loans using prudent underwriting standards regardless of their intent to hold or distribute them.

In addition, the Federal Reserve, alongside other regulators, has been working with the firms we supervise to increase their resilience to possible interest rate shocks...Our analysis to this point (undertaken outside of our annual stress test program) suggests that banking firms are capitalized to withstand the losses in asset valuations that would arise from large spikes in rates, which, moreover, would see an offset from the increase in the value of bank deposit franchises. This finding is consistent with the lack of widespread stress during the period of May through June 2013 when interest rates increased considerably. The next set of stress-test results, which we will release next month, will provide further insight on this point, both to regulators and to markets.

Some enhanced guidance and additional stress tests.  I think it would be reasonable to describe this response as underwhelming.  Would "additional guidance" have deterred lending activity during the housing bubble?  I somehow doubt it.  Indeed, Tarullo has his doubts:

While ad hoc supervisory action aimed at specific lending or risks is surely a useful tool, it has its limitations. First, it is a bit too soon to judge precisely how effective these supervisory actions--such as last year's leveraged lending guidance--have been. Second, even if they prove effective in containing discrete excesses, it is not clear that the somewhat deliberate supervisory process would be adequate to deal with a more pervasive reach for yield affecting many areas of credit extension. Third, and perhaps most important, the extent to which supervisory practice can either lean against the wind or increase the overall resiliency of the financial system is limited by the fact that it applies only to prudentially regulated firms. This circumstance creates an incentive for intermediation activities to migrate outside of the regulated sector.

The last point is critical.  Increased regulatory activity might just push more activity into the shadow banking realm.  There the threat of financial instability might increase exponentially, but without a regulator as a backstop.  I think this issue will tend to restrain the Fed's interest in heavy-handed regulatory activity.  

Tarullo follows with a discussing of time-varying policies, citing the example of increased loan-to-value requirements for mortgages as lending accelerates.  This is an area to watch, as Tarullo sees value in this approach:

...I would devote particular attention to policies that can act as the rough equivalent of an increase in interest rates for particular sources of funding. Such policies would be more responsive to problems that were building quickly because of certain kinds of credit, without regard to whether they were being deployed in one or many sectors of the economy...

Such policies could slow the progress of an asset bubble and, as Tarullo points out, provide additional time for policymakers to determine if the situation requires a change in overall monetary policy.  Ultimately, however, Tarullo is a realist.  He doesn't intent to put all his eggs in the macroprudential basket:

The foregoing discussion has considered the ways in which existing supervisory authority and new forms of macroprudential authority may allow monetary policymakers to avoid, or at least defer, raising interest rates to contain growing systemic risks under circumstances in which policy is falling well short of achieving one or both elements of the dual mandate. However, as has doubtless been apparent, I believe these alternative policy instruments have real limitations.

As he later says, this means that the Fed should not take the direct monetary policy action "off the table" when it comes to addressing financial instability.  What does that mean for policy in the near term?  Tarullo:

As I noted earlier, I do not think that at present we are confronted with a situation that would warrant a change in the monetary policy we have been pursuing...

Not terribly surprising.  After all, given that policymakers expect a long period of low rates, they obviously are not expecting sufficient financial instability to justify changing that outcome.  But expect more talk about the topic:

...But for that very reason, now is a good time to consider these issues more actively. One useful step would be development of a framework that would allow us to make a more analytic, less instinctual judgment on the potential tradeoffs between enhanced financial stability and reduced economic activity. This will be an intellectually challenging exercise, but in itself does not entail any changes in policy.

Bottom Line:  The Fed continues to explore the role of monetary policy in addressing asset bubbles.  But engaging such concerns head on with tighter policy remains a secondary option.  The first option is a variety of macroprudential tools.  Moreover, policymakers believe they have the time to explore such tools, much as they have had time to consider managing their expanded balance sheet.  They will also remain cautious to act out fear of increasing the risk of instability by driving activity out from under their purview.  At this point, my gut reaction is that by the time the Fed feels they are left with no other option but to tighten policy to limit financial instability risks, the damage will already have been done.  

 

Links for 2-25-14

Labor Department Weighs Cutting Data on Import and Export Prices to Save Money - Real Time Economics
The Great Recession! It's Right Behind You! - Free Exchange
Federal Reserve Appoints Portland Business Leader Charles Wilhoite to Western Economic Advisory Council - Oregonian
A Model of the Safe Asset Mechanism (SAM): Safety Traps and Economic Policy - NBER
What is the Stance of Monetary Policy - macroblog
Fracking Boom Leaves Texans Under a Toxic Cloud - Bloomberg
Dallas Fed's Fisher Wants to Continue Reducing Bond Purchases - Real Time Economics
You Won't Have Broadband Competition Without Regulation - Felix Salmon
Has Monetary Cooperation Broken Down? - PIEE
Why the Euro Inflation Number is Worse Than it Looks - Financial Times
My Quiz for Wannabe Keynesians - Roger Farmer
Global Growth After the G20 Summit - Gavyn Davies/Financial Times
Where a Higher Minimum Wage Hasn't Killed Jobs - Bloomberg
State Hiring Credits and Recent Job Growth - San Francisco Federal Reserve

Yellen's Debut as Chair

Janet Yellen made her first public comments as Federal Reserve Chair in a grueling, nearly day-long, testimony to the House Financial Services Committee.  Her testimony made clear that we should expect a high degree of policy continuity.  Indeed, she said so explicitly.  The taper is still on, but so too is the expectation of near-zero interest rates into 2015.  Data will need to get a lot more interesting in one direction or the other for the Fed to alter from its current path.  

In here testimony, Yellen highlighted recent improvement in the economy, but then turned her attention to ongoing underemployment indicators:

Nevertheless, the recovery in the labor market is far from complete. The unemployment rate is still well above levels that Federal Open Market Committee (FOMC) participants estimate is consistent with maximum sustainable employment. Those out of a job for more than six months continue to make up an unusually large fraction of the unemployed, and the number of people who are working part time but would prefer a full-time job remains very high. These observations underscore the importance of considering more than the unemployment rate when evaluating the condition of the U.S. labor market.

A visual reminder of the issue: 

This is a straightforward reminder of the Fed's view that the unemployment rate overstates improvement in labor markets and thus should be discounted when setting policy.  Consequently, policymakers believe they have room to hold interest rates at rock bottom levels for an extended period.  To be sure, there are challenges to this view, both internally and externally.  For instance, Philadelphia Federal Reserve President Charles Plosser today reiterated his view that asset purchases should end soon and also fretted that the Fed will be behind the curve with respect to interest rates.  Via Bloomberg:

“I’m worried that we’re going to be too late” to raise rates, Plosser told reporters after a speech at the University of Delaware in Newark. “I don’t want to chase the market, but we may have to end up having to do that” if investors act on anticipation of higher rates.

That remains a minority view at the Fed.  Matthew Boesler at Business Insider points us at UBS economists Drew Matus and Kevin Cummins, who challenge Yellen's belief that the long-term unemployed will keep a lid on inflation:

We do not view the long-term unemployed as necessarily "ready for work" and therefore believe that their ability to restrain wage pressures is limited. In other words, the unusually high number of long-term unemployed suggests that the natural rate of unemployment has increased. Indeed, when we have tested various unemployment rates' ability to predict inflation we found that the standard unemployment rate outperforms all other broader measures reported by the Bureau of Labor Statistics. Although we disagree with Yellen regarding the long-term unemployed, our research does suggest that, perhaps unsurprisingly, the number of part-timers does have an impact on restraining inflation.

I tend to think that we will not see clarity on this issue until unemployment approaches even nearer to 6%. That level has traditionally been associated with rising wages pressures in the past: 

The Fed would likely see a faster pace of wage gains as lending credence to the story that the drop in labor force participation is mostly a structural story.  At that point the Fed may begin rethinking the expected path of interest rates, depending on their interest in overshooting.  But in the absence of such early signs of inflationary pressures, the Fed will be content to raise rates only gradually.

With regards to monetary policy, Yellen reminds everyone that she helped design the current policy:

Turning to monetary policy, let me emphasize that I expect a great deal of continuity in the FOMC's approach to monetary policy. I served on the Committee as we formulated our current policy strategy and I strongly support that strategy, which is designed to fulfill the Federal Reserve's statutory mandate of maximum employment and price stability.

Yellen makes clear that the current pace of tapering is likely to continue:

If incoming information broadly supports the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.

Later, during the question and answer period, Yellen does however, open the door for a pause in the taper.  Via Pedro DaCosta and Victoria McGrane at the Wall Street Journal:

“I think what would cause the committee to consider a pause is a notable change in the outlook,” Ms. Yellen told lawmakers...

...“I was surprised that the jobs reports in December and January, the pace of job creation, was running under what I had anticipated. But we have to be very careful not to jump to conclusions in interpreting what those reports mean,” Ms. Yellen said. Recent bad weather may have been a drag on economic activity, she added, saying it would take some time to get a true sense of the underlying trend.

The January employment report was something of a mixed bag, with the unemployment rate edging down further to 6.6% while nonfarm payrolls disappointed again (!!!!) with a meager gain of 113k.  That said, I still do not believe this should dramatically alter your perception of the underlying pace of activity.  Variance in nonfarm payrolls is the norm, not the exception: 

Her disappointment in the numbers raises the possibility - albeit not my central case - that another weak number in the February report could prompt a pause.  My baseline case, however, is that even if it was weak, it would not effect the March outcome but instead, if repeated again, the outcome of the subsequent meeting.  Remember, the Fed wants to end asset purchases.  As long as they believe forward guidance is working, they will hesitate to pause the taper.  

Yellen was not deterred by the recent turmoil in emerging markets:

We have been watching closely the recent volatility in global financial markets. Our sense is that at this stage these developments do not pose a substantial risk to the U.S. economic outlook. We will, of course, continue to monitor the situation.

Yellen reiterates the current Evans rule framework for forward guidance, giving no indication that the thresholds are likely to be changed.  Jon Hilsenrath at the Wall Street Journal interprets this to mean that when the 6.5% unemployment rate threshold is breached, the Fed will simply switch to qualitative forward guidance.  I tend to agree.

Bottom Line:  Circumstances have not change sufficiently to prompt the Federal Reserve deviate from the current path of policy. 

Another Month, Another Employment Report

Tomorrow brings the January 2014 employment report.  The usual caveats apply:

• The monthly change in payrolls is a net number and represents only a fraction of the churn in the labor market.
• The employment data is heavily revised.  The preliminary number can greatly understate or overstate actual labor market behavior.
• Nasty weather might also have impacted the numbers.  Robin Harding at the Financial Times identifies other factors - expiration of unemployment benefits and annual revisions - that can also scramble the final numbers in the report.
• Forecasting the change in payrolls is thus something of a fool's game.  A game we all play nonetheless.  

 With all that said, I will venture a guess of a 200k gain in nonfarm payrolls for January:

This is a bit over consensus of 181k, but pretty much right in the middle of the range of estimates (125k-270k).  Full disclosure:  Last month my forecast was wildly optimistic.  Still, I think that report was an outlier.  Overall I don't see that the pace of improvement in the labor market has changed dramatically one way or another in the last few months.  The economy have been generating 180-200k jobs a month for two years despite the ups and downs in the data.  I suspect underlying activity continues to support a similar trend.  Any improvements that were evident prior to the December report were likely modest.  Indeed, I am skeptical that the pace of activity overall has dramatically improved either.  

As far as monetary policy, it is likely that only a very, very weak report would deter Fed officials from the current tapering agenda.  Even that is in question given that we will see another employment report - not to mention a plethora of other data - before the mid-March FOMC meeting.  It seems that hawks and doves alike want to wind down the asset purchase program, with the only difference being the pace of tapering.  Atlanta Federve Reserve President Dennis Lockhart sums up what I believe is the consensus view:

Absent a marked adverse change in the outlook for the economy, I think it is reasonable to expect a progression of similar moves, with the asset purchase program completely wound down by the fourth quarter of the year...

...But given my current views on the economy, I like the current positioning of policy.

It's in the right place for now, in my opinion. I think we policymakers should be patient—not too quick to respond to zigs and zags in the data.

Hawks, of course, would like a more rapid pace of tapering.  Philadelphia Federal Reserve President Charles Plosser basically said "enough is enough" yesterday:

 Notice that even though we are reducing the pace at which we are purchasing longer-term assets, we are still adding monetary policy accommodation. As I noted earlier, I believe the economy has already met the criteria of substantial improvement in labor market conditions, and the economic outlook has improved as well. So my preference would be that we conclude the purchases sooner rather than later...

...If the unemployment rate continues to drop at that pace, we will soon be at the 6.5 percent threshold in our forward guidance for interest rates.

Although the FOMC has indicated that it doesn't anticipate raising rates when the economy crosses that threshold, I do believe that we will have complicated our communications if we are still purchasing assets at that point. What is the argument for continuing to increase monetary policy accommodation when labor market conditions are improving rapidly, inflation has stabilized, and the outlook is for it to move back to goal?

Plosser would like to end asset purchases prior to hitting the unemployment threshold.  Problem is, that threshold could easily be hit tomorrow if not at the next meeting.  So, I guess all I can say to Plosser is "good luck with that."

Bottom Line:  Even a weak employment report may not be immediately pivotal for monetary policy; there is still another report to go before the next FOMC meeting.  A solid report, however, will further entrench the Fed's commitment to the current policy path. 

No End To Tapering Yet

Yesterday I said:

Altogether, the desire to end asset purchases suggests to me that what we have seen so far is insufficient to prompt the Fed to change their plans.  That is especially the case if the data does not soften further - if, for example, the next employment report shows a rebound in payroll growth and a further decline in the unemployment rate.

Today we learn via Bloomberg:

“The hurdle ought to remain pretty high for pausing in tapering,” Richmond Fed President Jeffrey Lacker said after a speech today in Winchester, Virginia. Chicago’s Charles Evans said in Detroit that policy makers probably face “a high hurdle to deviate” from $10 billion cuts in monthly bond buying at each of their next several meetings. Evans and Lacker don’t vote on policy this year.

One hawk, one dove, both concluding that the bar to stopping the taper is quite high.  Things need to get worse.  This just won't cut it:

Also take note of Jon Hilsenrath's view via the Wall Street Journal:

Last summer, as U.S. stock prices and emerging markets wobbled, the Federal Reserve was at the center of the turmoil. This time, the Fed might be just a bystander in the stock market selloff and not the proximate cause...

...The market, in short, is now pricing in a much easier Fed, not a tighter Fed. Movements in 10-year Treasury notes are telling the same story. Last summer, 10-year yields were rising because investors saw a tighter Fed. Now they’re falling. Investors seem to be reading a string of soft economic data – weaker car sales, a manufacturing slowdown, disappointing job growth – and concluding the economic coast is not as clear as it appeared just a few weeks ago.

I would suggest that the decline in rates indicates the Fed is too tight, not too easy.  Indeed, we would hope that they would only be tapering in the context of a rising interest rate environment as it would suggest that market participants were anticipating higher growth and inflation.  But the Fed doesn't see it that way.  They see lower rates as a signal that policy is easier.  And hence are not inclined to react to ease policy further by stopping the taper.

Moreover, I don't think the Fed believes that the end of asset purchases is impacting global markets because they are convinced that tapering is not tightening.  If it is tightening, then why should global markets react?  And even if it was tightening, the Fed wouldn't see it as their problem in the first place.  (To be sure, you may or may not agree, and I suggest you read Izabella Kaminska, Frances Coppola, and Felix Salmon for further insight into the topic.)

Bottom Line:  The Fed isn't ready to change course.  Recent turbulence is enough to peak their curiosity, not enough to suggest that tapering was premature.  

Markets Tumble. How Will the Fed React?

The financial markets are not being kind to freshly minted Federal Reserve Chair Janet Yellen.  The level of scrutiny she will face when she makes what is likely to be her first public appearance as Chair next week was already high, and is rising by the minute.  Global markets are faltering, and US equity markets tumbled Monday, with the weak ISM numbers reported to be the proximate cause of the sell-off:

The decline was driven by what can only be described as a jaw-dropping decline in the new order component:

Weather is suspected in the decline, and the ISM report offered some anecdotal support in that direction:

• "Poor weather impacted outbound and inbound shipments." (Fabricated Metal Products)
• "Good finish to 2013, but slow start to 2014, mostly attributed to weather." (Petroleum & Coal Products)
• "We have experienced many late deliveries during the past week due to the weather shutting down truck lines." (Plastics & Rubber Products)

That said, this is arguably more than about just weather, and at least partially should trigger a fresh assessment on the strength of the US economy.  To be sure, 2013 finished off with strong GDP numbers, strong enough to give the Fed hope that their 2014 forecast will be realized:

I suspect, however, that it is a bit too early to break out the bubbly.  Recent gains have been driven by inventory build-up.  Underlying growth still seems a bit tepid, in my view:

Moreover, concerns about the health of the global economy are growing.  Indeed, Ambrose Evans-Pritchard sees the threat of a global policy tightening in the making:

We now have a situation where the world's two biggest economies – the US and China – are both winding down stimulus in lockstep. Call it simultaneous G2 tightening if you want. Europe is tightening passively as its balance sheets shrinks, and M3 money fizzles out. So let us call it G3 tightening (even if the Europeans are doing it by mistake)

This amounts to something of a shock to large parts of the emerging market nexus. Is it therefore proper for these EM states to further compound the shock with pro-cyclical monetary (or fiscal) tightening, and to do so on a scale that could ultimately push the global economy closer to a deflation trap?

Sounds very similar to my concerns from last week:

Funny thing is that what the Fed sees as no tightening is evolving into a global tightening now as central banks rush to raise rates.  Consequently, money surges into the global safe asset - US Treasuries.  And, interestingly, I think that you can argue that this is much, much more disconcerting than last year's taper tantrum.  This seems to me to be a pretty clear global disinflationary shock.  And it isn't like inflation was on a runaway train to begin with.

To reiterate the last point, the Fed's decision to taper despite the obvious challenge to their inflation target looks increasingly questionable:

Fed policymakers don't even really have any positive near-term trends to hang their hats on:

Across the Curve points us to the Wall Street Journal's anecdotal account of intense pricing pressures (and still weak demand) facing firms:

Executives from companies as varied as General Electric Co. ,Kimberly-Clark Corp.  and Royal Caribbean Cruises Ltd. said some prices slipped in the last three months of the year—sometimes significantly—amid intense competition, weaker demand and pressure from cost-conscious customers.

Falling prices for adhesives weighed on Eastman Chemical Co., cheaper packaged coffee dragged on Starbucks Corp. , and “value and discounts” hit McDonald’s Corp. in the fourth quarter in what the fast food chain called a “street fight” for market share. Xerox Corp. is eyeing acquisitions that can “help us be more competitive on price pressure.”

Corporate revenues are showing the strain, whether from lower prices, weak demand or a combination of the two.

Despite the Fed's claim that tapering is not tightening, that it is the stock of assets held, not the flow, that matters, that they could change the policy mix without changing the level of accommodation, market participants are acting as if tapering is indeed tightening.  Five year, five year forward inflation expectations have tumbled:

And bond market participants, who had been starting to get optimistic that improving economic conditions would prompt the Fed to tighten sooner than later are now rethinking that scenario:

If this keeps up, it looks like Yellen will face an early test in her first few weeks as Chair.   And I would say there is a good chance this does keep up until the Fed changes direction and decides that the US economy may not have reached escape velocity as believed.  Of course, the early voice was a hawkish voice which signaled exactly the opposite, as reported by Michael Derby at the Wall Street Journal:

 With regard to Fed policy, “I can’t say that things have changed just because of this market action,” Mr. Fisher said in an interview on Fox Business Network after the markets closed Monday.

The hawks fought long and hard for the taper; they will not be easily dissuaded from by a few sloppy days on Wall Street.  Remember, the hawks believe asset purchases are fueling a potential asset bubble to begin with.  Falling stock prices will only verify their bias and justify the policy.  

Of course, the hawks will not be driving a policy shift.  That shift would come from the center.  But I sense that the center have something in common with the hawks - the center wants out of asset purchases too, which makes me think the bar to holding asset purchases steady at the next meeting is relatively high.  Still, a deflationary shock should make them think twice.  Then again, already low inflation should have made them think three or four times before tapering in the first place.   Altogether, the desire to end asset purchases suggests to me that what we have seen so far is insufficient to prompt the Fed to change their plans.  That is especially the case if the data does not soften further - if, for example, the next employment report shows a rebound in payroll growth and a further decline in the unemployment rate.

Another problem we have at the moment is the transition at the Federal Reserve.  In many respects, Yellen is still an unknown commodity.  Will she live up to her dovish reputation, or will she surprise on the hawkish side?  I have to imagine that Yellen is not thrilled by this turn of events.  Of course, no one would be, but she is in the unfortunate position of facing the House Financial Services Committee for the first time next week, and her words will carry an extra weight.  If she opens the door to tapering the taper, so to speak, odds are she will be credited for a global rally - but then she has to follow through.  If she acts as if the Fed is moving full steam ahead, then she will be blamed for the turmoil that ensues - and maybe have to reverse course after all.  

Bottom Line:  The Fed is once again in a familiar place.  They try to pull back on policy, and markets tumble.  Tightening has repeatedly proved to come too early; one wonders if the Fed would have had to keep doing more if they didn't keep promising to do less.  If history is any guide, they will eventually reverse course.  But that same history would suggest that they need to see conditions deteriorate further before they act.