Scoreboard: Fuzzy Fed

Wall Street slumped after Fed minutes failed to give clarity on a taper, but the bond market seems to be pricing one in amid strong data.

Well there was no additional guidance from the Fed’s minutes as to when this long-expected taper will occur – although the ‘market’ seems to disagree as there were some big moves afterwards. On paper, the committee simply noted that a taper might occur in “coming months” if the economy unfolds as expected.

Prior to the minutes the St Louis Fed president James Bullard suggested that it could even happen in December – of course we know it most certainly will not, but perhaps the market moved on that. From my point of view, the Fed is continuing to be vague, adding to policy uncertainty and making no effort whatsoever to provide clear sign posts as to when they will stop printing money.

However the bond market for its part seems to think we are closer to tapering, perhaps taking Bullard at his word. So the US 10-year Treasury yield is up about 5 bps to 2.76 per cent at the time of writing. If you take the Fed at face value that makes sense, because nearly all the data flow has been stronger than expected.

Take retail sales, which were released last night. They rose 0.4 per cent in October, which was much stronger than the 0.1 per cent expected, and this result follows a flat outcome the month prior. Core sales were also stronger than expected at 0.3 per cent, following a gain of a similar magnitude the month prior. Then business sales rose 0.2 per cent and inventories surged 0.6 per cent on the expectation of even stronger business activity in the period ahead.

The mistake however is to assume the Fed is being reasonable, which of course it isn’t. I’m not convinced that we are a step closer to a taper as it seems quite clear that the committee will continue to move the goal posts and make whatever excuse it can to print money. They are the facts as we have seen so far.

So what’s changed? The problem the Fed has got is that it expects the market to keep the yield curve relatively stable when it withdraws from the market. This of course is a ludicrous expectation given that the Fed is the single largest buyer of US treasuries. If it exits the market, that would create a sizable void, one which only a fool would want to fill.

They’re trapped, basically. That’s why they spent so much time discussing communication “tactics and strategy” – i.e. how they can convince the market that tapering is not a tightening in rates, and how they can continue to keep rates low. Methods discussed include: verbal reassurance that rates won’t rise; reducing the 6.5 per cent unemployment threshold; and a “projected” inflation threshold below which rates would not rise.

The immediate flaw that comes to mind is that the Fed has no credibility and the market simply does not believe what it says anymore. So these changes to forward guidance simply won’t work. This is what happens when you continually move the goal posts and make things up as you go. People stop listening – which by the way is what wiser heads at the Fed warned would happen.

Anyway, markets elsewhere took fright as well – stocks were spooked and after the minutes were released the offer was on. As I write, and with about an hour left to trade, the S&P500 is off 0.2 per cent, losing 0.4 per cent (1784) after the minutes. The Dow is then off 36 points (15,929), and the Nasdaq is flat basically (3930).

Gold was the other big mover, losing $30, $20 of which occurred after the minutes. Silver wasn’t too far behind, losing 2.3 per cent. Crude for its part rose 0.7 per cent on Brent ($107.8).

Finally in the forex space, the Australian dollar lost 50 pips after the minutes (0.9320) and is down 68 pips from yesterday afternoon. Similarly, the euro is 120 pips lower (1.3423) although a good chunk of that move occurred after US economic data was released. Anyway, you get the gist of the price action and what drove it, so I’ll leave it there.

The only other thing to note data-wise is that US inflation remains at 1.7 per cent year-on-year, while existing home sales fell 3.2 per cent in October, which will no doubt get any remaining pessimists in the market all worked up about another Armageddon.

So then for our market today, the SPI points to a modest fall for our market (off 5 points), but otherwise there isn’t much data flow. Tonight it’s worth watching out for a speech by the Reserve Bank of Australia governor on the Australian dollar at 2005 AEDT. Outside of that we see the European PMIs, a few more fed speakers (James Bullard and Jeffrey Lacker), US producer prices, the Philly Fed index and, of course, jobless claims.


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