Fed December 2013 Meeting
“Beginning in January, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $35 billion per month rather than $40 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $40 billion per month rather than $45 billion per month.” FOMC Statement December 18, 2013
After spending $4 trillion over the course of a few years to purchase mortgage backed securities (MBS’s) and U.S. Treasuries (T-bonds) with money created out of thin air, in an effort to keep interest rates low in order to keep the banks solvent and to spur economic growth and employment, the Fed decided yesterday to slow the pace of its purchases of MBS’s and T-bonds from $85 billion a month to $75 billion.
The Fed’s move came after nearly a year of bluffing/threatening to taper their quantitative easing program (QE). The reduced asset purchases will continue starting in January and at $75 billion a month still represent a massive $900 billion annual expansion of the Fed’s balance sheet.
Why They Did It
The Fed has been engaged in quantitative easing for nearly five years. A program that appears to have no end involving the incessant printing of dollars would eventually undermine the value of the dollar. The Fed is aware that an un backed currency depends upon the confidence in the issuer to be a prudent steward of the issuance of that currency.
Therefore, if holders of U.S. dollars and dollar denominated securities like T-bonds, begin to think that QE is forever and that the dollar will be printed in endless amounts, the dollar would lose its attractiveness and cause it to lose a portion of its value resulting in price inflation for those transacting in U.S. dollars.
Paradoxically, it is this ability to print dollars that gives some U.S. bond holders comfort.
In addition, in order not to create the perception that QE is forever, the Fed has been threatening to taper their QE program for nearly a year. Having not tapered in September and October the Fed might have been perceived as crying wolf if they did not taper QE at least in a ceremonial way in December.
Tapering a small amount in December provides the Fed with a dose of credibility such that they can continue and even increase QE if they wish to.
Indeed, the FOMC minutes note “the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s economic outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.”
Thus, whether to continue QE, increase it or to further taper it is dependent on how the economy, labor market and inflation perform in the coming months.
While the decision to taper QE and perhaps eventually end QE is dependent upon how the economy performs in the coming months, the Fed “reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program (QE) ends and the economic recovery strengthens.”
This is an admission that the economy is structurally weak and requires artificially low interest rates to support it and that the Fed anticipates that to remain so.
Selling the Tapering Is Not Tightening Narrative
By promising to keep rates low even after QE ends the Fed is trying to achieve acceptance of their narrative that tapering is not tightening. It is. The only reason interest rates have been as low as they have been the past five years is because the Fed has spent $4 trillion to keep them low. When the Fed began talking about tapering in June interest rates nearly doubled.
The Fed realizes that the economy, the stock and real estate markets and the U.S. government’s spending and borrowing requirements rely on low interest rates and that the economy would tank if interest rates rose. The Fed, however, is desperate not to add another trillion dollars worth of MBS’s and T-Bonds to their balance sheet this year, so they have been floating the tapering is not tightening concept by insisting that they will keep interest rates low even after they shut down the QE program.
Yesterday, post taper, interest rates didn’t move much. This is because yesterday’s small taper had been anticipated widely and priced into the market for months and the Fed gave no definitive time table to end QE. In addition, the market knows that Janet Yellen will be the Fed Chair next year and that her views on monetary policy are even more “accomodative” than Mr. Bernanke’s. Further tapers or threats or perceived threats of further tapers will cause interest rates to rise and the stock and real estate markets to correct.
The markets will be back to their normal Fed watch; examining every piece of economic data to determine whether the Fed will deem the economy strong enough to consider another taper. The markets will also have to get used to Yellen speak and how she signals future Fed actions. Our view is at the first sign of economic troubles or rising interest rates, Ms. Yellen will fire up the dollar printing press and increase QE.
Yesterday was Mr. Bernanke’s last meeting as Chairman of the Federal Reserve. Mr. Bernanke must have thought that yesterday’s taper was essential for his legacy lest he be remembered as one who just printed and ran. Yesterday’s ceremonial tapering of QE may have been designed to make it appear that Mr. Bernanke’s tenure as Fed Chairman was a success as he embarked on an unprecedented dollar printing scheme and it worked and as such he started to close down the program. This spurious interpretation fails to note that Mr. Bernanke blew $4 trillion over four years to little or no positive effect on the overall economy. Mr. Bernanke voting to cut only $10 billion a month from the $85 billion a month the Fed is printing to take effect in January when he is gone is not a legacy preserving move.
The Fed’s Meaningless Taper