The Fed’s ACTIONS
- Fed maintains $85B monthly purchase program: $45B Treasury, $40B Agency MBS, reinvesting maturing securities
- Forward guidance: maintaining 6.5% unemployment rate and inflation running above 2.5% as threshold for consideration for raising Federal Funds rate; policy makers generally expect the first rate hike in mid-2015
- Major surprise as market expectations were for cut of QE3 by roughly $10B
- Economic Projections:
- GDP revised down for 2013/2014/2015
- Unemployment roughly unchanged
- Inflation revised down in 2014
What it MEANS
- Markets rallied – given the VERY broad expectation of tapering, equities jumped +1%; yields across the curve tumbled - down 15bps on 5s, 17bps on 7s (MBS sensitive) and 14bps on 10s; 2yr yield fell about 5 bps
- USD collapsed – more liquidity from Fed means more USD floating around
WHY it Happened
- Circular logic?? “…tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market.” The Fed is ultimately pointing the finger back at themselves – comments made in late May, and by Bernanke at June press conference set this tightening process in action creating an unintended consequence of transparency
- Data dependent: despite a stated unemployment rate of 7.3%, labor market conditions are really quite weak; higher borrowing costs (read: mortgages and car loans) are acting as a buffer on economic activity
- Fiscal cliff / debt ceiling: Bernanke is a scholar of the Great Depression and certainly knows that tightening monetary policy coupled with restrictive (or dysfunctional) fiscal policy will almost certainly push the economy back into recession
- Disinflation: as shown by the Fed’s decline in inflation expectations, they can’t justify slowing purchases in the face of soft prices
WHERE We Go From Here
- Fed remains massive buyer of Treasury/MBS at a time when issuance – especially Treasury – is slowing. Asset prices will continue to be distorted because of the Fed’s buying; speculative positions will come back into the market
- Continued uncertainty over fiscal situation; possible government shut down in coming weeks; we don’t anticipate an outright default by the government, though selective payments may be delayed
- Continued uncertainty over next Chair-person; Janet Yellen is not a foregone conclusion, yet, though her fingerprints are all over today’s decision (she’s a notorious labor market advocate)
- A return to “bad news is good news” mindset; economic data that suggests ‘moderate’ growth will support the Fed’s position while strong economic data may be negative for risk assets as it may support less monetary accommodation
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