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The Longest Journey Begins With Delaying the First Step

Everyone expected markets to provide a lot of late-day volatility today, and so they did. The Fed apparently doesn’t mind surprising the market with a non-consensus outcome when that surprise gooses stocks and bonds higher. Here are some (fairly unstructured) thoughts about today’s declaration from the Fed that there will be no “taper” in its QE program yet:

  1. This has nothing to do with the fact that there was a minor wiggle in the Employment data, some weakness in Retail Sales, and some other disappointments this month. If that is now the standard…that the Fed plans to expand its balance sheet without bound as long as growth is not smashing the cover off the ball, then we are truly lost for QE will never, ever end. This month’s numbers were all within the normal variation for economic data, which do in fact vary even when the underlying economy is not. The old standard was “ameliorate a deep recession.” Then Greenspan turned that to “resist even a mild recession.” And now, is the standard “robust growth no matter what the long-term cost?” I don’t think so, and so I reject the notion that the failure to begin the taper has anything to do with the growth numbers.
  2. Similarly, the inflation numbers cannot be the reason. Core inflation is now rising, and the Fed has previously recognized that some of the decline in inflation has been due to transient effects of the sequester. Median inflation has remained steady at 2.1%, which is basically the Fed’s long-term target. The cost of 10-year deflation floors in the market are at the lowest level since they began to trade in 2009 (see chart, source Bloomberg and BGC Partners – the price is in up-front basis points). So it isn’t a lingering fear of deflation that has the Fed concerned.


  1. The Fed speakers over the last month have had ample opportunity to shoot down the idea that taper would start at this meeting, which has been the consensus for a long time. None of them did so, implying that the Fed was comfortable with that consensus. But something changed in the last few days, and that is that the odds-on next Fed Chairman went from being Larry Summers to being Janet Yellen, who happened to be in the meeting today.[1] Does this change the dynamic? Absolutely, since one reason Bernanke has started thinking and talking about tapering is so as to leave as clean a slate as possible so that the next Chairman wouldn’t have to start his term by tightening (sorry, I mean “reducing accommodation”) and scaring asset markets. Once Summers withdrew his name, Yellen’s vote got automatically much more important and the urgency to start the taper much less (since Yellen doesn’t believe there are any important costs to QE). Indeed, in his post-meeting presser Bernanke noted that the “first step” on a taper is “possible this year.” That is far to the dovish side of what the Street was expecting, but consistent with the notion that Yellen’s opinion will carry a heavy weight unless someone else is appointed to the post.
  2. Yellen said last June that the Fed’s objective is a quick return to full employment, and that Fed action might be justified “to insure against adverse shocks [emphasis mine],” or even if the Fed concludes that the recovery “is unlikely to proceed at a satisfactory pace.” So, perhaps I need to reconsider my point #1 above. Maybe that is the standard now.
  3. If in fact QE has no cost, then there is no reason to ever stop it. In fact, it should be accelerated. Most Fed officials seem recently to be coming to the realization that there is highly unlikely to be a costless economic remedy, even if they are not sure what the costs are or think they can be contained. Those people clearly have no voice any more, even though it appeared that those views in the last few months were gaining currency (no pun intended, since the dollar dropped to the lowest level since February after the announcement today – a Fed that was edging however slowly to being more-hawkish than average was good for the dollar; a weak, more-dovish than average central bank will be worse for the dollar all else equal). This is pedal-to-the-metal time.
  4. TIPS got a lot more expensive today, with the 10-year rallying 20bps to 0.475% and breakevens up 4.5bps one day before the Treasury auctions another slug of them. The auction ought still to go well, because caution has been thrown to the wind by our beloved central bankers. This is also good for commodities, and they rose today led by precious and industrial metals. Is it good for equities? Well…
  5. Equity analysts are like puppies. They completely forget what happened 5 minutes ago and every experience is brand new. There is never any context. So stocks shot higher today, with the S&P gaining 1.2%, because of the dovish Fed and lower interest rates. But over the last few months, as the taper grew closer and interest rates shot higher, all equities did was move to new highs. So, higher interest rates and a (relatively) hawkish Fed doesn’t hurt stock prices, but lower interest rates and a dovish Fed helps them? This may be why the Fed thinks that buying bonds keeps interest rates low and selling bonds doesn’t raise them. It’s a strange market-based notion of a perpetual motion machine. For goodness’ sake, let’s crank interest rates down 200bps, back up 200bps, down 200bps, and keep doing that and the stock market will be at 1,000,000 before you know it. Prosperity! But in fact it is probably more like a bicycle pump. Pushing down inflates the tire, pulling up doesn’t deflate it. It seems costless. However, if you keep doing that, eventually the tire will pop.
  6. Speaking of the perpetual motion machine, I enjoyed this little gem from the FOMC statement:

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative…

Really? It hasn’t worked recently. Lest they forget: the taper hadn’t started yet, but until today it was busy being discounted in the bond market. I don’t expect that merely continuing to buy bonds into the SOMA will push rates much lower again. We all know that this game ends, and we know how it ends. With 10-year notes at 2.70% I wouldn’t be selling them, but I also wouldn’t expect a massive rally to unfold. I would hold long positions in September and October, because those are the right months in which to hold bonds (especially with debt ceiling fight #2, Syria, Italy’s government disintegrating, and Germany’s election), but if the market gave me 2.45% to sell, I would sell.

[1] Note, though, that no person who has ever held the office of Fed Vice-Chairman has later been appointed to be Chairman…although Donald Kohn, since he was Vice-Chairman from 2006-2010, would also represent a departure from this same tradition. However, he was not in the room.

  1. eric
    September 18, 2013 at 9:18 pm

    I hadn’t thought of the Yellen/Summers theory. That has some plausibility. But it also seemed to me, for all the same reasons you mention (no really new data, plenty of time to hint) that the FED really wanted to catch the markets by surprise. Why? Well, they certainly got more bang out of the bond market than the did out of the stock market with the announcement. Maybe that’s what they wanted? It has seemed to me for some time that the FED was surprised and dismayed at their announcement of their intention to “taper”. the bond market tanked and the stock market shrugged it off. I think they were hoping for the opposite.

    (I realize that’s not a full theory, but its all I have! 🙂

    • September 18, 2013 at 9:26 pm

      I kicked myself this afternoon because the Summers/Yellen thing didn’t occur to me, naturally, until AFTER the surprise. 🙂

      They might have wanted to get a big reaction, but they can’t have it both ways. They can’t say “we want to be transparent, and we measure transparency by how little the market moves when we have an announcement,” and then go whack the market with a 2×4. I’m all for reducing transparency, but don’t say you ARE going to be transparent and then try to surprise the market! That’s a good way to lose any respect the bond market had for you in the first place.

  2. HP Bunker
    September 18, 2013 at 10:49 pm

    Great column (and worth reading for the “Equities analysts are like puppies” comment alone)!

  3. Chris
    September 19, 2013 at 2:47 am

    Apart from the discussion of the feasability (and potency of the FED) as well as the involved costs: very interesting observation that the FEDs targeted ‘intervention’ rate heightens from “deep recession” over “mild recession” to “tepid growth”. Why not further increase to 5% growth an minimum?

    Thanks for your repeatedly wonderful posts!

    • September 19, 2013 at 6:21 am

      thanks! Generous comments today! Refer your friends! 🙂

  4. September 19, 2013 at 6:04 am

    I dont want to politicize the blog, but apparently, this is what the modern capitalism is: cash rich corporations make their owners richer and richer while the rest of us can be safely discarded? Truly, the new Normal is then buying assets by the Central Banks as soon as LT interest rates near the 3 per cent threshold…

    Or, maybe it is all just a plan to get us over October 1st (aka the debt ceiling debacle)?

    • September 19, 2013 at 6:23 am

      I think calling it a “plan” is generous. It’s a plan in the same way that a cavalry charge that fails turns into a planned retreat. It’s in the “dang, what do we do RIGHT NOW” phase with no thought (or no weight) given to the longer-term consequences. But I guess that has been the m.o. all along.

  5. September 19, 2013 at 4:45 pm

    I don’t think the Fed were ever going to taper this month, I think the market just got ahead of themselves, pricing it in as near certainty. Bernanke has always said he wants unemployment to drop to 6.5 first and thats still a way off. Sometimes the market doesn’t always get what the market wants!

    • September 19, 2013 at 4:54 pm

      Agreed that the market doesn’t always get what it wants. But for years, the standard has been that the market says what they are expecting, and then a Fed speaker or two indicates if they are off base or a Hilsenrath article suggests the market is wrong-headed. In this case, all of those indications suggested that the Fed was comfortable with the market’s positioning. This is what ‘transparency’ is all about, after all. Now, I don’t WANT the Fed to be transparent, as I think it’s bad for the market, but the Fed at least CLAIMS it wants to be transparent!

      Thanks for posting! Welcome.

  6. Ray
    September 20, 2013 at 12:11 pm

    I think the Fed is starting to lose credibility quickly. First no warning of “no taper” and your reason for it makes perfect sense (Yellen in) and the reason given was data. Less than 2 days later, “maybe taper in Oct”, what changed?

  7. eric
    September 20, 2013 at 2:53 pm

    Today’s antics were extra weird. And not terribly consistent with the Yellen theory. I’m back to my view that they are trying to figure out how to make some markets go up and other down at the same time. Either that, or they are telling their friends what to buy and sell in advance and making them a killing.

  8. HP Bunker
    September 20, 2013 at 6:05 pm

    My own plan going forward is to ignore everything that anyone at the Fed says, and only pay attention to what they do. What they did yesterday is decide to keep buying bonds and MBS at the same rate. That should carry infinitely greater weight with investors than offhand remarks by Bullard today. Talk, as they say, is cheap.

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