The final Fed Open Market Committee meeting of the year concluded yesterday and as usual, the FOMC issued its policy statement afterward. Ahead of the meeting there was much anticipation about what the Fed would do when (and if) its “Operation Twist” stops at the end of this year.
You may recall that Operation Twist involved the Fed buying apprx. $45 billion of long-dated bonds each month, while simultaneously selling an equal amount of short-dated Treasuries in an effort to put downward pressure on long-term interest rates. The FOMC policy statement yesterday did confirm that Operation Twist will cease at the end of the year as expected.
The surprise in the statement was the Fed’s announcement that it will continue buying $45 billion a month in long-dated Treasuries indefinitely. This is in addition to its ongoing policy of buying $40 billion a month in mortgage-backed securities. So starting in January, the Fed will be buying $85 billion in long-dated securities, without any offsetting sales of short-term Treasury securities – indefinitely. This latest move is being called QE4.
The move to continue purchasing $45 billion in Treasuries each month, without offsetting sales, was seen as more aggressive easing by the Fed and suggests that the FOMC is concerned that economic growth may be slowing, although the statement did not say so formally.
Initially, the FOMC statement buoyed stock prices since it is widely agreed that QE is bullish for equities, and now there will effectively be $45 billion more QE bond operations a month going forward. The gains in the stock markets were quickly pared, however.
Surprising to some, the bond market reacted quite negatively to the announcement of more QE, since additional bond buying raises concern about future inflation. This even though the FOMC statement stated that the Committee expects inflation to remain at 2% or below over the next few years. The bond vigilantes weren’t buying it. Bonds fell hard, especially the 30-year Treasuries.
There was something else new in yesterday’s policy statement. The Fed has been very vague when it comes to disclosing just how long it might keep the Fed funds rate at 0-1/4%. The statement read as follows:
“In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent…” [Emphasis added.]
No one knows, of course, when the unemployment rate will get to 6.5%, but I guess Bernanke & Co. felt the need to give the Fed watchers something to noodle on. Thanks, Ben… The statement also added that the Fed funds rate would not start to rise unless inflation rises above 2.5%. That was assumed already, but at least the Fed made it official.
Fiscal Cliff: As of late yesterday, talk out of Washington was that the negotiations were “stalled.” Now that’s a real surprise! The negotiations have been stalled from the very beginning. President Obama said publicly on Tuesday that he very much believes the Republicans will cave to his demands before letting the economy go over the cliff.
Yesterday afternoon Speaker Boehner instructed Republicans in the House not to make travel plans for the holidays. House Majority Leader Eric Cantor said he plans to keep Republicans in Washington right up to Christmas Eve, and even bring them back before New Year’s Day if necessary.
I continue to believe that President Obama is willing to let the economy go over the cliff and blame the Republicans. Obama is hell-bent on raising taxes on those in the top two brackets; he campaigned on it; and I don’t think he will back off. It remains to be seen if the Republicans will cave.
I think the continued stalemate over the fiscal cliff is another factor that weighed on the bond markets yesterday. I have been warning for the last several months that it wouldn’t take much to send the bond market into a tailspin. Maybe it’s on its way.
I addressed the bond market bubble at length in my December 4 E-Letter including what you can do about it. With the fiscal cliff fast approaching, I suggest that you consider taking action before the end of the year!
Have a great weekend everyone!
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