A Deeper Analysis Of Today's FOMC Policy Statement

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 |  Includes: DIA, QQQ, SPY
by: Kenny Yang

After the Fed decided not to taper in the September FOMC meeting, market participants are more anxious than ever to await for more clues on the timing of the first taper. A compilation by the WSJ shows that the majority of FOMC members prefer to await additional data that confirm a well-anchored recovery before beginning to taper QE. Today's statement echoes that sentiment. Below, I broke down the analysis of the statement into the usual five paragraphs. For the full statement, please see the Fed's website.

First Paragraph:

Paragraph one usually includes a general assessment of the economy and a discussion on the conditions of both the labour market and inflation. Overall, there were minor changes in this paragraph to account for the recent weakness in economic data. Information received since the September FOMC meeting "generally" suggested that economic activity expanded at a moderate pace. The language is a bit weaker with the word "generally" included in today's statement. The household sector "slowed somewhat in recent months" vs. the September statement's "household sector has been strengthening". The FOMC removed its language on risks regarding high mortgage rates but kept its wording that "fiscal policy is restraining economic growth". The language referring to inflation is unchanged from the September statement.

Second Paragraph:

Paragraph two always contains a sentence to emphasize that the Fed has a dual mandate that seeks to maximum employment in context of price stability. The language regarding the outlook for the labor market is unchanged with the FOMC expecting gradual decline in the unemployment rate over time. The language on downside risks remains unchanged with the Fed stating that downside risks diminished, on net, since last fall. However, the Fed did remove the warning regarding tightening of financial condition, which could negatively impact the economy and labour market. Therefore, the Fed's economic outlook is slightly brighter and that reflects the recent drop in interest rate since the September FOMC meeting. The 10-year treasury yield has dropped 30 bps since then.

Third Paragraph:

Paragraph three provides an overview of its current monetary policy. As expected, the FOMC is keeping the monthly purchase size of QE steady at $85 billion per month ($40 billion in MBS and $45 billion in treasury securities). The FOMC kept the statement on awaiting for additional data before tapering QE, which suggests a December taper is very unlikely. The committee is also continuing to reinvest principal payments of its agency debt securities and these combined measures will help to "promote a strong economic recovery".

Fourth Paragraph:

Paragraph four provides a brief outlook on how the asset purchase program may change over time. As expected, the FOMC kept its language that: "[FOMC] will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved". The Fed reminds investors that the asset purchase is not on a "preset course" and that it is heavily data dependent.

Fifth Paragraph:

Paragraph five outlines Fed's forward guidance and this section is unchanged from the prior statement. The main message to investors and traders is that the Fed will keep the federal funds rate low at 0-0.25% until the unemployment rate drops below 6.5% and inflation expectation doesn't go above 2.5%. This implies that rates will still remain low despite the possibility of tapering next spring. Investors should be cautious on betting on an earlier rate hike and Bill Gross argued that rates may remain low until 2016 or 2017.

Implications for the Market:

As outlined in my market outlook article I wrote a week ago after the September job report, the weak labour market will delay tapering and is positive for risk assets. Although fundamentals (earnings and GDP growth) are still weak, ultra loose monetary policy by the Fed will push stocks and high yield bonds higher in the short term. The S&P500 (NYSEARCA:SPY), Nasdaq (NASDAQ:QQQ) and Dow Jones (NYSEARCA:DIA) will continue to hit record highs despite concerns about overvaluation. Fixed income securities (NYSEARCA:IEF) (NYSEARCA:HYG) will also benefit from a more dovish Fed especially if Janet Yellen is confirmed by the Senate to lead the Federal Reserve. The U.S. dollar (NYSEARCA:UUP) may continue to struggle especially against the Euro. Moreover, precious metal like Gold (NYSEARCA:GLD) will benefit from the increasing size of Fed's balance, which is projected to rise to above the $4 trillion level.

Conclusion:

All in all, there were minor changes in today's FOMC statement compared to September. All changes reflect a slower than expected recovery in the labor market and weaker household sector. However, the Fed did also alter its risk assessment stating that downside risks have diminished and that higher interest rates are less of a threat than it was in September. The slight better outlook provided in the statement caused both stocks and bonds to fall after the statement is released. Nonetheless, risk assets will still rally into the New Year. A small correction is likely in the near term similar to a correction that began after the September FOMC meeting.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article is for informational purposes only. The author is not a professional economist and the analysis is solely based on his opinions. Investors are recommended to conduct further due diligence before committing capital to any investment.