Yesterday’s Wrap-Up: Bernanke Puts QE3 on The Table; Fed Funds to Stay Low Until Late 2014
In statements released in Washington, the Federal Open Market Committee (FOMC) stated intentions to keep their benchmark interest rate low through at least late 2014, and voiced that they expect continued high unemployment and “subdued” inflation; this was a more dovish release than the market had expected. “The Committee expects to maintain a highly accommodative stance for monetary policy… Economic conditions — including low rates of resource utilization and a subdued outlook for inflation over the medium run — are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.” Many anticipated just simple “wordsmithing”, and certainly not something very tangible out of this particular release. The extension of the plan to keep the fed funds rate “exceptionally low” through late 2014, from mid-2013, was apparently tangible enough. Risk markets reversed early losses and were up significantly after the release of the FOMC statement, with the dollar declining -0.39% to 79.486, the 10yr treasury falling 6bps to 2.002%, and the S&P 500 closing up +0.87%. (We’re looking at a high inverse correlation between the USD and the S&P 500; selling dollars means moving money to more risky assets- this relationship obviously changes at different phases of the business cycle.) Nine of seventeen officials anticipate borrowing costs will remain below 1.0% through the end of 2014, and six officials expect zero rates to remain into 2015. The Fed’s estimate for growth in 2013, using the central tendency approach, is projected at 2.8% to 3.2%; inflation is likely to fall below the 2% goal. The committee did not change its plans to lengthen the maturity of its current bond holdings, a move dubbed “Operation Twist”. Policy makers are “prepared to provide further monetary accommodation if employment is not making sufficient progress towards our assessment of its maximum level, or if inflation shows signs of moving further below its mandate-consistent rate,” Mr. Bernanke said at a news conference today after the FOMC meeting. Bond buying is “an option that’s certainly on the table.”
European stocks were lower after economic data released showed the U.K. economy has contracted more than estimated, Ericsson AB’s earnings missed analyst estimates, and Novartis AG told investors sales may stagnate in the near future; the Euro Stoxx 50 closed down -0.45%. According to the Office for National Statistics, the U.K. economy shrank 0.2% in 4Q 2011. The Portuguese 5yr climbed to a record 18.88% YTM and the Italian 10yr climbed 11bps before the U.S. FOMC release. By 4pm EST Italian 10yrs were up only +4bps, while the U.K., France, Germany, Spain, and Switzerland all experienced declines in debt of similar maturity.
Morning Commentary: Yield Curve Talk
Thinking logically about the yield curve after yesterdays FOMC release, we understand the curve is likely to continue flattening, while the belly of the curve (5yrs-7yrs) will continue to outperform, and the front end should stay anchored until the market begins to price-in inflation. Inflation won’t be a concern until the economy can generate some real growth, which will not likely happen until the labor market starts to make a comeback. Bond traders focusing on curve extension trades have been rewarded more than they could have anticipated. The 10yr treasury yield fell significantly after the release, down to 1.958% this morning, and looks to technically be in a position to fall to its support at 1.80% in the near-term; a friend, analyst TJ Marta with Bloomberg’s First Word Team, has said the 10yr may not find its bottom until 1.50%. 5yr notes are testing all time lows of 76bps, and 2yrs are testing resistance around 20bps- close to their all time low at 14bps. Now that we have even more clarity on the Fed’s intentions, the market will focus on whether Greece can secure a debt deal sooner, rather than later. Caterpillar Inc., the world’s largest producer of construction and mining equipment, posted 4Q earnings and full-year profits that beat analysts’ estimates.
In Europe, sovereign yields have fallen considerably, with Italian and Spanish 10yr down 19 & 18bps respectively; stocks are much higher with the Euro Stoxx 50 up +1.65%.