The Fed saved the world economy during 2009, but has clearly inflated liquidity excessively in the last 2 years, and monetary policy normalization is long over-due. However, yesterday’s surprise has some logic and its critics exaggerate its importance, in our view. Here are a few reasons why.

First, the question of whether this decision is a change in big picture monetary policy, or just a timing issue. Most people have taken it to be signal that the Fed is bound to be even more dovish than before or than expected. This is an exaggeration. There is not enough evidence that this is a change in approach, and there is enough evidence to believe this is just a timing issue based on how economic data has recently evolved, and how markets globally had reacted to the preparation towards ‘tapering’ since May. And Bernanke emphasized many of these in his press conference yesterday.

The Fed started to hint at ‘tapering’ by the fall of this year back in May, mostly in June. Since then a few very important things have happened, which can explain why yesterday’s decision makes some sense as a timing decision:

– The market produced a serious interest rates move since the tapering discussion started in May/June. The so-called risk-free rates on US Treasuries produced an adjustment that would make any central bank proud of its verbal intervention powers. Five-year rates jumped up to 120 bps from early May to early September, while 10-year rates did almost 140bps in the same period. In both cases those rates almost doubled, showing their low bases.

– If there is one sector that matters for the recovery in the US economy is housing, and it had recovered nicely since earlier this year. However, the taper debate since May-June and its effect on rates (point above) has caused concerns about a pause, as the mortgage market was clearly affected by the jump in market rates. This was most likely a key concern at the FOMC meeting.

– Beyond housing, broader data on the US economy, which was showing a nice recovery during 1H13, started to show fatigue during the summer. Not necessarily the case for China and Europe, which is good news.

– The international reaction to the tapering debate was particularly acute and painful in emerging markets. An equal-weight basket of 10 EM currencies fell 10% during the relevant period, while the local markets index that shows both rates and FX fell roughly 20% in the same period. According to Bernanke’s press conference yesterday this is now an area of focus for the Fed, given that he had denied responsibility in the past but went out of his way yesterday to discuss the impact of US rates on emerging markets.

– Finally, people in the FOMC cannot be immune to potential short-term risks, and the political fights around fiscal issues in the US are bound to produce volatility over the next 2-4 weeks, which might be yet another reason to wait.

All the above were most likely issues discussed, and most importantly are decent reasons to wait for the next meeting. On the other hand, the best reason to have done it yesterday is that the market expected it, and as such, it would have produced no significant additional impact while putting the Fed on a path towards normalization.

We see yesterday’s decision as a rational balance between the reasons above, and not as a sea change in what we should expect on policy and global liquidity. It does help markets in the short-term, and as long as it makes it harder for the Fed to make this decision in the next meeting, it could a more meaningful boost to markets. But there is not enough reason to believe that, and we expect tapering to start in one of the next 2 meetings. Moreover, the fiscal fights in the US over the next few weeks are bound to crash the party, at least in the very short-term.