Ben Bernanke's Fed surprised the vast majority of investors yesterday when the FOMC decided not to begin tapering the stimulus being provided to the economy via the monthly purchase of $85 billion in bonds and mortgage-backed securities. The move came as a surprise because "Gentle Ben" has been "talking taper" since May. And since May, both the bond and stock markets have spent the vast majority of their days trying to come to grips with what "the taper" would mean.
But at the end of the day Wednesday, all the consternation associated with "the taper" had gone for naught. Sure, Mr. Bernanke made it clear that his Fed (well, until January that is) could begin cutting back on the QE program at any time. However at this point in time, Bernanke said that the FOMC did not feel the economic data was in line with what the FOMC needed to see in order to justify a reduction in their quantitative easing efforts.
Apparently the key to the decision was the "tightening of financial conditions seen in recent months." In English, this refers to the dramatic rise in interest rates that has occurred since the Fed Chairman first broached the idea of tapering the expenditures on QE. The chart below of the yield on the 10-year makes this point pretty clear.
This Is What "Tightening Financial Conditions" Look Like
What is ironic here is the simple fact that the move up in bond yields was in direct response to Bernanke "talking taper." While the Fed has been adamant that tapering isn't the same as tightening, bond traders didn't buy into the argument. When asked about this issue at the press conference following the FOMC announcement, Mr. Bernanke said that the Fed tried to communicate its outlook for monetary policy as clearly as possible. However, the chart of the 10-year would seem to suggest that the Bernanke gang has failed miserably on this count.
While rates were artificially low in early May and thus had plenty of room to move up without impacting the economy, the fact that the yield on the 10-year nearly doubled after talk of tapering began hasn't gone unnoticed in the mortgage market. The NAHB Homebuilder Confidence report confirmed this on Tuesday as NAHB Chairman Rick Judson wrote, "Many [builders] are reporting some hesitancy on the part of buyers due to the sharp increase in interest rates." Therefore, it is a safe bet that at least a portion of the decision to not start tapering the QE program was out of concern over what higher rates might do to the housing market.
Erring on the Side of Caution - Still
According to the surveys, the majority of economists expected the Fed to begin tapering their $85 billion per month bond buying program. Yet, if one had been paying attention to the economic data of late, this wasn't exactly a layup call.
While the Fed has told us that they are targeting an unemployment rate of 6.5% before they would take action on rates, a great many economic reports have come in on the punk side recently. As such, it wasn't exactly a surprise to see Mr. Bernanke decide to err on the side of caution - again.
If you will recall, Ben Bernanke is one of the foremost experts on the Great Depression. Furthermore, the Fed Chairman has often expressed the view that he wants to make darn sure the U.S. does not fall into the deflationary spiral that has plagued Japan for nearly twenty-five years. Anyone who has studied economic history knows that once deflation grows roots in an economy it can be very difficult to eradicate.
So, with the economic data looking less than inspiring lately and his term coming to an end in just a few months, it is a decent bet that Bernanke convinced his fellow committee members to stay the course on the QE program - just in case.
Although Janet Yellen has been a key player in the development of current Fed policy, the bottom line is no one can be sure what next year's Fed will look like. Some have argued that the 2014 FOMC will have a much more "hawkish" roster and as such, Bernanke may be looking to squeeze every last drop of stimulus into the economy before he departs. After all, they don't call him "Helicopter Ben" for nothing!
Publishing Note: I have an early meeting on Friday and will publish a morning report. Regular "State" reports will return on Monday.
Turning to This Morning ...
Follow through appears to be the phrase of the day as global markets took Wall Street's cue and moved higher. The decision by the Fed not to taper its QE program continues to be the focal point. However, some of the enthusiasm may be curbed at this time due to growing concerns about the U.S. debt ceiling debate, which appears to be turning more acrimonious each day. U.S. stock futures are modestly higher in the early going but off their best levels.
Here are the Pre-Market indicators we review each morning before the opening bell ...
Major Foreign Markets:
- Japan: +1.80%
- Hong Kong: +1.67%
- Shanghai: +0.29%
- London: +1.44%
- Germany: +1.11%
- France: +0.95%
- Italy: +1.17%
- Spain: +1.01%
Crude Oil Futures: +$0.29 to $108.36
Gold: +$54.10 to $1364.71
Dollar: lower against the yen and euro, higher vs. pound.
10-Year Bond Yield: Currently trading at 2.700%
Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: +4.48
- Dow Jones Industrial Average: +32
- NASDAQ Composite: +6.74
Thought For The Day ... It's not what it's worth, it's where you can sell it - Bernard Baruch
Positions in stocks mentioned: none