The FOMC just delivered the long-awaited first reduction in the pace of asset purchases the Federal Reserve makes under its quantitative easing program known as QE3.
This came as a surprise to many, but markets are taking it in stride — stocks are higher while both short-term and long-term interest rates are lower in the wake of the release of the decision.
Reactions are coming in from Wall Street strategists, many of whom predicted that the FOMC would hold off on “tapering” until its January or March meeting.
Below is a sampling of their responses to tapering.
Alan Ruskin, Deutsche Bank: “This statement tends to elevate the importance of the inflation rate in decision making should it be meaningfully undershooting target, which is very constructive for risky assets. Other important changes include: the FOMC forecast dots have shifted to a median of 0.75% fed funds at the end of 2015, the median on ‘the dots’ the 2016 is down 25bps to 1.75%. Taking the above, this is a very dovish taper-lite where the Fed has done its utmost to provide an offset with its forward guidance, notably on the inclusion of inflation in the unemployment threshold. This has clearly tempered the interest rate response which is exactly what they would have wanted. Risk has responded positively almost immediately, which should be ample vindication that the Fed should not have waited, and fears of a negative impact on financial conditions were exaggerated. The action today finally gets the uncertainty of when they would taper out the way which is another helpful factor for risk. The fed fund futures curve has barely budged, and even the shape of the curve has shown little change suggesting the Fed’s balancing act was largely priced in. Risky assets are now seen remaining robust into year-end.”
Steven Englander, Citi: “The Fed statement is being viewed as a very dovish tapering — small reduction in purchases, indication weakening of unemployment trigger, UR trigger now conditional on inflation, no date for end. In some ways the key may be the absence of an end-date to tapering — from a markets perspective it pushes out the date of any possible rate hike. In addition they lowered the lower bound of some of the core inflation forecasts, which may reinforce the low rates guidance. Even the 30-40 per cent of the market that were looking for a March and beyond tapering seems to be satisfied by the comfort that the Fed is offering…Overall risk friendly — investors seem to have gotten over their fear of tapering and the surprise may be how irrelevant currency fundamentals are when the news is that the alcohol content of the punch bowl is being reduced so gently after so much spiking that no one even notices. Overall it looks as if the short-end of the rates curve is anchored low enough for long enough for risk to be bought. There may be some hiccups on the way (and some take profit/closing of positions), but this is as gentle a tapering as anyone could have expected.”
Chris Rupkey, Bank of Tokyo-Mitsubishi UFJ: “What the heck, the stock market likes it, up 184 points. Tapering was supposed to hurt stocks, morphine drip and all that nonsense. Why is the stock market embracing QE tapering today? They are still buying $US75 billion each month of course, but also perhaps doing better because the Fed watered it down. They changed some other rules of the game. They tried to tell us that interest rates will go up very slowly… if at all. They inserted a line near the end of the FOMC statement saying it is likely that it will be appropriate to keep short-term rates at zero ‘well past’ the time that the unemployment rate declines below 6.5%, especially if inflation is below its 2% target. As you recall, they had been saying they would sit down to talk about lifting interest rates when unemployment fell to 6.5%. Net net, the Fed bit the bullet and tapered QE by $US10 billion today, but they are still buying $US75 billion per month. At this rate, they might be stringing out the QE exit and cut $US10 billion per month for the next 7 or 8 meetings. We hope not. The big news today is trying to tell the market they would keep rates at zero ‘well past’ the unemployment rate hitting 6.5%.”
Eric Green, TD Securities: “The FOMC tapered asset purchases by $US10B with a reduction in both $US5B in Treasuries and $US5B in MBS to take shape in January. There was only one dissent for this action (Rosengren) which demonstrates more agreement than was the case when Bernanke launched operation Twist. We knew the Fed was eager to move beyond a buying program that had become increasingly anachronistic within an economy no longer in re-hab, and we also knew they had all the economic justification to do so in December. That they chose to move one meeting earlier than expected, and at a time when the prevailing view was not December, demonstrates a level of confidence in the outlook that has now found its way more forcefully into the post meeting statement. Forward guidance received a face lift, but no more and on balance remains as fuzzy as ever. This is consistent with our view that whatever changes would be made would be more qualitative than quantitative.”
Michael Gapen, Barclays: “Notably, in our view, the December statement said risks to the growth outlook are “nearly balanced”, which is a fairly strong shift from the previous language solely focused on downside risks in prior statements. Altogether, the passage of the Bipartisan Budget Act of 2013 that, in our view, reduces the likelihood of fiscal brinkmanship, appeared to play an important role in the December decision, just as the pending federal government shutdown and debt ceiling debate posed in September when the committee did not alter its policy stance. We did believe that the committee would strengthen its forward guidance if it decided to taper, particularly given the sharp fall in the unemployment rate in recent months. We read the December statement as imposing a ‘soft’ inflation floor in its policy rate guidance. The statement says the committee ‘anticipates’ that it will keep the policy rate within its current target range ‘well past the time that the unemployment rate declines below 6-1/2 per cent, especially if projected inflation continues to run below the Committee’s 2 per cent longer-run goal.’ This is not as strong as saying the committee will refrain from raising rates until its inflation projections are at or above their longer-run target, but it does provide more guidance that the committee is prepared to let the unemployment rate drift lower if inflation remains subdued.”
Andrew Wilkinson, Miller Tabak: “The Fed shaved $US5 billion from each of its bond purchase programs and so announced the onset of tapering at two-times the pace we had anticipated. Within the statement there is little change in the tone — unemployment remains elevated but is improving, while the restraint from fiscal policy maybe diminishing. Inflation remains stable. With ongoing policy accommodation the Fed expects to witness growth pick-up from its recent pace and for unemployment to gradually decline consistent with its dual mandate. Risks to the economic outlook are more balanced it noted. A Pyrrhic victory for those who feared inflation was a reason to hold off from tapering — the FOMC noted that inflation persistently below its 2% objective could pose risks to economic performance. Its focus is on watching for signs of an expected return to target.”
Emad Mostaque, Noah Capital Markets: “It is clear that they don’t expect inflation to now exceed 2% before 2017 (central tendency), with unemployment at ~5.5% by then, not too different from now and not sufficient to stoke inflation (I think the NAIRU is now closer to 4%, but obviously employment is odd as the participation rate may increase as we head toward it). This leaves us in a curious position wherein 2% inflation suddenly becomes a floor/target for hiking and we are likely stuck at ZIRP unless we see a mighty capex-led US recovery (unlikely in my opinion). Any hits to the bullish view of the market on the US will push down long rates further as the reality of the Fed holding its hands up and admitting there’s not much else they can do for employment kicks in, making me comfortable with my 1% long-term target on the US 10 year given I believe current economic projections are overly optimistic in assuming continued rises in corporate margins and incorrect inferences from key data points.”
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