FedWatch: Dots entertainment
Federal Reserve policymakers did pretty much as we expected following their two-day meeting: they maintained the modest $10 billion of monthly tapering, acknowledged the severe weather’s temporary impact on the economy and replaced the quantitative 6.5% unemployment threshold for potential tightening with a range of somewhat nebulous, i.e., ill-defined qualitative factors such as labor market conditions, inflation and inflation expectations, and financial developments. No surprises here. By getting away from a numeric target, the Fed gave itself some room to maneuver—it’s no longer boxed in by a number.
So if there were no surprises, why did equities and Treasuries, particularly on the short-to-intermediate end of the market, sell-off and the dollar strengthen? Primarily because the economic and interest-rate projections accompanying the statement were a bit of a surprise—the dots representing policymakers’ potential votes on the benchmark funds rate were revised slightly higher at the end of 2015 and 2016, indicating the target funds rate could move off zero by early to mid-spring 2015, vs. market expectations for them to remain pat well into fall. This view was further reinforced when Janet Yellen, in her first post-meeting press conference as Fed chair, equated the statement’s suggestion the Fed would wait “a considerable time” after the end of quantitative easing to consider tightening to “six months.” Do the math. If the Fed maintains tapering at its current pace, QE ends in early fall. Six months later gets you to the end of the first quarter/beginning of the second in 2015.
To be sure, Yellen went out of her way to bolster the view that the benchmark funds rate will remain on a shallow glide path for a long time; that is, even when they start to move, the movements will be slow and minimal. But in a market that parses every sentence, indeed every word in the post-meeting statements issued by the policy-setting Federal Open Market Committee (FOMC), the slight change on the outlook for the rate was enough to rattle the markets. Of course, we would expect the risk markets to recover once they realize that the Fed’s willingness to potentially raise rates sooner than expected is probably more a good than a bad thing. If policymakers feel confident to start raising rates, this suggests they feel the economy is on a more solid footing—and outcome equities historically would applaud. But as we’ve learned, the market doesn’t like surprises, so for today, it’s sell now and analyze later.