As we have not tired of showing over the past five years, and while correlation is not causation, the near uniformity between the increase in the Fed’s balance sheet and the performance of risk assets shown in the chart below (via Diapason), leaves zero doubt who, in the absence of any self-sustained economic recovery, has been responsible for the stock market’s “outperformance” since the onset of the Great Financial Crisis.
What we have also not shown constantly for years, is that as a result of the wealth transfer with each incremental program of central bank intervention in the capital markets, the rich got richer, the poor got poorer, the US middle class is ever closer to extinction, and as the WSJ added moments ago, “As QE winds down, it leaves a divided society.”
With that said, today’s FOMC announcement at 2:00 PM Eastern will certainly have a substantial impact on risk, and on the economy. One thing is known: when QE1 and QE2 were unwound, the hit to the S&P (and bond inversely, bond yields) was swift and sharp. Furthermore, the unwinds back then were said to take place at a time when the economy (also) was on the verge of a “self-sustaining” recovery. The fact that not only open-ended QE emerged but the unprecedented liquidity injection in Japan too, which inject more stimulus into the risk markets than the program launched at the depths of the market crisis, shows that it was all a lie. This time will not be different.
With all that out of the way, and with less than three hours to go, here is a succinct summary courtesy of RanSquawk, of all the outstanding issues, and potential options for Bernanke, as the 2:00 PM hour approaches.
- Expectations for Fed to begin to taper asset purchases by USD 10-15bln
- Ranges for pace of Treasury purchases: high USD 45bln, low USD 25bln
- Ranges for pace of MBS purchases: high USD 45bln, low USD 30bln
- Some see FOMC lowering unemployment threshold from current 6.5%
- Summary of Economic Projections and Press Conference from Fed Chairman Bernanke follow the announcement
Most analysts are expecting the FOMC to begin to slow down their asset purchases from the current USD 85bln, made up of USD 45bln in Treasuries and USD 40bln in MBS. A New York think tank report last week showed the Fed could unveil USD 15bln taper of their QE3 program in USD 10bln in Treasury’s and USD 5bln in MBS purchases. If the Fed do begin to taper asset purchases at this meeting, it is likely Fed Chairman Bernanke will try to calm markets following the announcement by saying that slowing down asset purchases is not a tightening of policy and also reiterating that policy will remain highly accommodative in the foreseeable future. Some have suggested, including Goldman Sachs, that the FOMC could adjust their forward guidance in an attempt to calm markets by lowering their threshold for a rate hike from the current 6.5%.
Many members on the FOMC have said that any tapering of asset purchases is data dependant and recent economic data has not been too favourable with the most recent Non-Farm Payrolls report showing 169K jobs created vs. Exp. 180K, below the monthly gain of 200K many members on the FOMC have said they would like to see consistently before a slow down of asset purchases. Another risk to the tapering argument comes from the looming fiscal situation in the US, with the current fiscal year ending on September 30th and still no sign of an agreement in Congress regarding sequestration, which is likely to have an impact on economic growth if an agreement is not reached. Other issues potentially having an impact could be the geopolitical situation in Syria and the volatility seen in emerging markets as Fed tapering started to be priced in. Furthermore, the FOMC are expected to lower their 2013 growth forecast when they release their economic projections, which some argue would be a reason not to taper at this meeting.
Another issue that may come into focus, particularly during Bernanke’s press conference, could be that of his successor. Bernanke’s term as chairman is due to come to an end in January with Obama set to nominate his successor during the Fall. Former Treasury Secretary Larry Summers has this week ruled himself out of the running for the job which supported Treasury’s as the renowned dove, Janet Yellen, is now firm favourite for the role.
Market Reactions: obviously these refer to a world in which logic and a normal market applied. In the “new normal“, neither is quite relevant.
If the FOMC do decide to taper asset purchases it is likely a knee-jerk reaction lower in Treasuries, equity markets and gold will be seen, with the USD strengthening, as liquidity is withdrawn from the market. With equities in the US trading around record highs, there is scope for downside, however Treasuries trade at their lowest levels since July 2011 with the 10y yield in the US recently trading above 3.0% for the first time in over two years. However if the Fed do begin to taper, the reaction in Treasuries could depend on how the central bank slow their buying. If the Fed just slow purchases in Treasuries, the long-end of the curve is likely to come under pressure as the majority of Fed purchases are in longer-dated Treasuries.
If the Fed lowers their forward guidance threshold, alongside tapering, Eurodollars would likely be subject to upside. Markets are currently pricing in a first rate hike by the Fed in Q4 2014 so red and green contracts could see the most volatility with any lowering of the forward guidance threshold. However, some do not expect the Fed to change their forward guidance as Bernanke can reiterate that a fall in the unemployment rate to 6.5% is not a trigger for a rate hike but rather a guide.
If the Fed unexpectedly abstains from tapering then it is likely the USD will come under very heavy selling pressure and upside will be observed in Treasuries, equity markets and gold, as it is largely priced in that the FOMC will taper at this meeting. However, as mentioned previously, equity markets are currently trading near record highs which could mean any scope for upside may be limited, although there would be room for a decline in yields which would help support stocks. If the Fed does not taper at this meeting then many expect them to refrain from doing so at the October meeting as there is no scheduled press conference after the announcement from Fed Chairman Bernanke. This would then mean the next opportunity to slow down asset purchases would be the policy meeting on December 18th.
Economic Projections from the June meeting
The following FOMC forecasts will be updated at 1900BST/1300CDT alongside the monetary policy statement. As a side note, the forecast horizon is expected to be increased to 2016 although these figures are likely to be similar to 2015.
Sees end 2013 unemployment rate at 7.2% – 7.3%
Sees end 2014 unemployment rate at 6.5% – 6.8%
Sees end 2015 unemployment rate at 5.8% – 6.2%
Sees 2013 GDP growth rate at 2.3% – 2.6%
Sees 2014 GDP growth rate at 3.0% – 3.5%
Sees 2015 GDP growth rate at 2.9% – 3.6%
Sees 2013 PCE inflation of 0.8% – 1.2%
Sees 2014 PCE inflation of 1.4% – 2.0%
Sees 2015 PCE inflation of 1.6% – 2.0%
What others are expecting…
- Bank of America – Sees taper in December although risk is a “token-taper” of USD 10-15bln
- Goldman Sachs – Sees USD 10bln taper, all in Treasuries, and strengthening of forward guidance
- Citi – Sees USD 10-15bln taper and forward guidance to be shifted out
- JPMorgan – Sees USD 15bln taper of USD 10bln in Treasuries and USD 5bln in MBS
- Barclays – Sees small first taper and any lowering of 6.5% unemployment threshold as very unlikely
- Deutsche Bank – Sees USD 5bln taper in MBS and USD 10bln in Treasuries, does not expect adjustment to forward guidance
- Fed watcher Hilsenrath said Fed officials exploring how to justify low rates far into future and forecasts could show economy at “full employment” by 2016.
Finally, as Hilsenrath also notes, it is quite possible that in the 2:30 pm press conference “perhaps Mr. Bernanke will finally confirm that he plans to leave the Fed when his term expires at the end of January.“