Fed Likely to Remain Accommodative in the Near Term

Magnotta@AmyLMagnotta, CFA, Brinker Capital

Equity market investors expressed concern last week after the release of the minutes from the latest FOMC meeting suggested that the Federal Reserve is considering slowing down the pace of the current quantitative easing (QE) program. The Fed is currently purchasing $85 billion of U.S. Treasury and Agency mortgage-backed securities per month.

The Fed has changed its stance on when policy would potentially move to a tightening bias, from emphasizing a calendar date to basing it on economic data. The Fed has stated that it would not raise short-term rates until the unemployment rate fell to 6.5% as long as inflation is not expected to rise above 2.5%. With inflation currently running well below their threshold and with the unemployment rate elevated at 7.9%, it is likely the Fed is more focused on bringing down the employment rate, potentially at the expense of higher inflation.

With short-term interest rates already at the zero bound, the asset purchases are attempting to promote the same result as additional cuts to the fed funds rate. Even if the Fed tapers off their asset purchases in the next few months, any QE is still easing. They would just be taking their foot off of the accelerator. We feel that economic growth should remain tepid in the first half of the year and not strong enough to bring down the unemployment rate significantly, so the Fed is likely to keep their accommodative stance. In addition, the key members of the FOMC – Bernanke, Yellen and Dudley – all lean to the dovish side with respect to monetary policy.

Before actual tightening occurs, the Fed will first have to end QE. When the Fed stops asset purchases, it would be in the context of an improving economy. An improving economy is typically a positive for asset prices. As ISI Group shows in the following charts, equity prices have eventually increased in past episodes of policy tightening.

The Fed raised interest rates from 1.00% to 5.25% from June 2004 to June 2006. After a modest correction, equity prices moved up substantially.

The Fed raised interest rates from 1.00% to 5.25% from June 2004 to June 2006. After a modest correction, equity prices moved up substantially.

The Fed tightened in more aggressive increments during the 1994-1995 period. The equity markets moves sideways for a period of time, and then ultimately moved higher.

The Fed tightened in more aggressive increments during the 1994-1995 period. The equity markets moves sideways for a period of time, and then ultimately moved higher.

Did Chairman Bernanke Seal the Reelection of Barack Obama?

Andy Rosenberger, Brinker Capital

Presidential and Vice Presidential candidates Mitt Romney and Paul Ryan wasted no time in criticizing the Federal Reserve’s newest measure to stimulate the U.S. economy through additional monetary policy, otherwise known as Quantitative Easing (QE3). Within hours of the Fed announcement, Mitt Romney likened the need for more easing to failed Obama policies while Paul Ryan later said it represented “sugar-high economics”. The two fiscally minded candidates are understandably frustrated with the new measures by the Fed.

According to intrade.com, a market-based prediction market whereby speculators can gamble real money on the outcome of future events, the probability of President Obama’s reelection jumped significantly after the announcement by the Fed. The spike in reelection odds is the largest since the death of Osama bin Laden in May of last year.

According to intrade.com, President Obama now has over a 66% chance of winning the election this November, an increase of over 5% since the QE3 announcement. With such a dramatic move in reelection odds, the news of new quantitative easing is certainly a blow to the Romney campaign and a major reason why Mitt Romney has publicly said he would not reappoint Chairman Bernanke if given the chance.

Chart Source: www.intrade.com, 9/17/12

Quantitative Easing Ad Infinitum?

Amy Magnotta, CFA, Brinker Capital

The Federal Open Market Committee (FOMC) launched an open-ended quantitative easing program yesterday. The Fed will purchase $40 billion of Agency mortgage-backed securities (MBS) per month with no specified end date. The Fed will continue its Operation Twist program through December, which includes the purchase of $45 billion per month of longer-dated Treasuries.

The MBS purchases will continue indefinitely until the outlook for the labor market improves “substantially,” which is a different approach than previous easing programs. The Fed also used a communication tool, stating that short-term rates will remain zero-bound until at least mid-2015 (instead of late-2014).

The Fed did not express any concern with inflation, stating it will likely run at or below its 2% objective over the medium term. However, the market is not convinced and inflation expectations moved up significantly after the announcement.

U.S. 5-Year Breakeven Inflation Rate (Source: Bloomberg)U.S. 5-Year Breakeven Inflation Rate

Gold (white) and Silver (orange) Prices (Source: Bloomberg)

The equity markets reacted positively, with the S&P 500 Index gaining +1.6% on the day. An open-ended quantitative easing program may be even more supportive for equities. It is clear the Fed is not ready to stop easing until they see more meaningful and sustainable growth. They want to see more of an improvement in the housing and labor markets. Low rates are here to stay. While the Fed’s actions will increase the risk appetite of investors, we still need help from fiscal policy before year end.

The full FOMC statement can be found here and their updated economic projections here.

Have the Odds of More Quantitative Easing Increased?

Amy Magnotta, CFA, Brinker Capital

Last Friday’s disappointing employment report raises the odds of more quantitative easing by the Fed. Payroll employment increased by only 96,000, and the increases reported in prior months were revised lower. The unemployment rate fell, but only due to a decline in the labor force. The labor force participation rate has fallen to 63.5%, the lowest level since September 1981. With GDP growth of just +1.7%, the U.S. economy is not growing at a pace sufficient to create needed job gains. The chart below shows just how weak job creation has been compared to previous recoveries. (Bureau of Labor Statistics).

Job Creation

This employment report did not offer the Federal Reserve evidence of a “substantial and sustainable strengthening in the pace of the economic recovery”[1] that they are seeking.  As a result, the odds that the Federal Open Market Committee (FOMC) will announce further easing at their meeting on September 12/13 have increased.  Consensus seems to expect additional easing, and a lack of announcement to that effect could disappoint the markets.  There has been talk of an open-ended buying program of U.S. Treasuries and/or mortgage-backed securities.  The FOMC could also extend their rate guidance, perhaps pledging low rates into 2015.

Inflation remains within the Fed’s target level, so they still have room to ease; however, the effectiveness of further monetary policy easing is diminishing.  While the Fed feels obligated to act to fulfill their mandate of economic growth, the bigger problems facing the U.S. economy – the fiscal cliff, the Eurozone crisis and slower growth in China – are outside the Fed’s control.  More certainty surrounding fiscal policy would allow businesses pick up the pace of hiring and investment, boosting economic growth


[1] Ben Bernanke, Federal Reserve Chairman.