Quick Thoughts on the Fed Decision
By: Billy Schmohl, 12/18/13
The Fed announced today that they will begin to taper the quantitative easing program by $10 billion, to $75 billion per month, commencing January 1st, 2014. The Fed reiterated their intent to keep the Federal Funds Rate between 0 – 0.25% until unemployment dips below 6.5%, so long as inflation stays below 2.5%. If inflation remains weak, the Federal Funds Rate could remain at that level if unemployment dips below 6.5%.
Treasuries were weak this morning, weakened further upon the Fed announcement, then went slightly stronger on the day, and are again near pre-announcement levels on the long end. Usually an announcement of a $10 billion per month buyer being removed from the market would have a weakening effect, though the choppiness implies that the market simply does not know how to react. We are in unprecedented territory. Municipals tend to lag treasuries, and will likely follow their lead.
Equities are going bonkers, implying the market thinks the economy is strong enough to support itself. I would expect equities to be a little weaker since borrowing costs are projected to increase and tapering was not necessarily fully priced in, though some tapering was already priced in, and the outlook on the employment market has improved.
I thought they would wait, or taper by closer to $5 billion. Employment growth is improving, and the manufacturing data from Monday, December 16, 2013, really helped, but inflation remains below the Fed’s longer-term objective of 2%, with their preferred gauge registering 1.1% through October. If growth slows, we run the risk of deflation. The speed and timing of further tapering will be dependent on the success of this first round.
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