Saturday, December 21, 2013

Fed TAPERS; Bernanke and Co. Surprise Many

Fed TAPERS; Bernanke and Co. Surprise Many
Written: Evening of September 18, 2013

I titled my previous blog, Can We Taper? My response was no, and I explained in quick detail why the FOMC wouldn’t or couldn’t initiate a reduction in its asset purchases just yet. Well I was wrong. Maybe not completely but nonetheless, the Fed announced its plan to begin reducing the size of QE and this post explains my take on the market moving events that occurred earlier today.

Let me first summarize the key data Dr. Bernanke reported today in his final press conference as chairman of the FOMC. Below is a bullet point summary.
·      The Fed announced that it would begin a modest reduction in asset purchases (QE program) that would begin next month to the tune of 10 Billion Dollars. This would incorporate a decrease of $5B in Treasury purchases and $5B in Mortgage Backed Securities.
·      The committee expects:
o    The Unemployment Rate to continue decreasing to a level between 6.3 – 6.6 % by the end of 2014 and reach a long run level (past 2016) of 5.2-5.8%
o   Inflation to reach its objective target of 2% by 2016
o   GDP growth to finish 2013 between 2.2-2.3%, 2.8-3.2% in 2014, and 2.2-2.4% in the long run
·      Dr. Bernanke stated that the economy had created over 2.9 million jobs since the recession and unemployment has dropped a whole percentage from 8% to 7% during this time period.
·      Non-farm payroll measures have read on average near 200k each month since QE3 began.

I stated in my last post that I wouldn’t be completely surprised if the FOMC began tapering, however I didn’t expect it. My view was that although improvements in economic data were present, we needed to sustain those economic measures for at least a couple more months before the Fed tapered its highly accommodative monetary policy. I also wrote that the rhetoric of the statement would be what influenced the markets and that was indeed the case today as well.

Lets touch on Dr. Bernanke’s rhetoric. The chairman acknowledged that growth over the past few years has been slow. He cited the housing bubble, the subsequent financial crisis, contractionary fiscal policy and also some bad luck as examples of that. He also acknowledged that labor market conditions have been tough and stated that QE measures along with decreasing fiscal drag out of Washington should help improve these conditions. He explained that although a reduction in asset purchases will begin next month, QE is still appropriate for the economy as national production has been sluggish. He further stated that with unemployment and inflation still not reaching the fed’s target values for each respective measure, the committee will continue to purchase Treasuries and Mortgage Backed Securities to some extent.

As far as for a continued taper, he stated that, “further measured steps” that would be “deliberate and data dependent” would be taken in the future. He emphasized, “asset purchases are not on a pre-set course” and that the FOMC expected to “
Maintain the Federal Funds Target Rate, in its current near 0 range, well past the time unemployment falls below 6.5%, especially if projected inflation continues to run below 2%.”

As I listened to the chairman speak and jotted down notes of his press conference, I felt like I kept hearing reasons why the Fed SHOULD NOT taper. Yet we did, and so my first thought was maybe the committee is now starting to see the risk and feel the pressure of a massively ballooning balance sheet? I then started thinking about the motive for this decision. Did most voting members of the committee simply believe it was a healthy and appropriate time to begin tapering the asset purchases of the Fed; or rather, suddenly realize the above-mentioned risk of a highly accommodative monetary policy, and decide to taper in defense of another financial type crisis? I personally think it was a little bit of both. I am under the impression that if we could eliminate the affects of the recent government shut down, this policy decision would have been suspected by most. But the shut down threw off economic measurements, and so I personally believed the Fed would have wanted to wait longer for more data to confirm a decision. I think this occurrence forced a bad hand on the committee; who may have seen the data skew from Washington’s shutdown as far too much a risk, and needed to maintain a cutoff for balance sheet increases. Also, this may have been an opportunity to control risk using their balance sheet while also supporting markets through dovish commentary. The chairman talked about interest rates still remaining low for a considerable period and that a major reason rates would remain low was due to the substantial holdings that the Fed is currently responsible for. Equity markets would still enjoy the benefits of cheap capital markets, which would continue to help stimulate them. In my opinion the press conference was rather dovish. It seemed the committee wanted to assure investors or other market participants and citizens that accommodation in the markets will most certainly still be available. While giving this assurance, they were able to also provide a slight reduction in purchases to show hawkish market participants that the reduction process has begun. This process could have giving comfort to both camps of the taper debate, enhancing the broad based rally we saw earlier in equities.

Todays FOMC press conference was very crucial. My perception was that the Fed still maintained a dovish outlook, but had realized it needed to begin de-risking, in order to avoid any future, major economic disruptions. The job that Fed committee members take on is one of great stress and pressure, yet I will say I feel confident in those members. This policy move surprised me along with many others, but like many things, the move makes more sense in hindsight. The recent economic data displays clear improvement, and although I would have liked to see a few more releases of new data, I must tip my hat to Dr. Bernanke and co. They found a creative way to continue stimulating markets and the general economy while also slowly beginning the process of shrinking the size of their balance sheet. Most importantly… the markets were MUCH HIGHER today! We got a nice little rest over last week, and boomed today. Lets ride the uptrend through Christmas now.

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