Market Reaction To FOMC Announcement

Data from : http://www.cmegroup.com/trading/interest-rates/stir/30-day-federal-fund.html

(Before data was taken at 2:00 pm, After data was recorded at market closing prices)

S&P 500

Before : 1138.64
After : 1172.53

Treasuries

2 year

Before : 0.27
After : 0.20

10 Year

Before : 2.33
After : 2.26

30 Year

Before : 3.68
After : 3.64

Inflation Expectations

2 year inflation swaps

Before : 1.43
After : 1.39

5 Year TIPS Breakeven rate

Before : 1.81
After : 1.78

10 Year TIPS spread

Before : 2.27
After : 2.22

30 Year TIPS spread

Before : 2.64
After : 2.61

Bloomberg Commodity Index

Before : 1601.42
After : 1598.48


EUR USD
Before : 1.4221
After : 1.4339


(Data from bloomberg.com)


The market reaction to the Fed announcement today was certainly interesting. Fed Funds Futures unsurprisingly fell in reaction to the commitment to leave them at 0% until 2013. Equities took a while to figure out how they felt, seesawing up and down before finally rising about 3% from their pre-meeting rallies. Treasury yields fell, especially at the medium end of the curve (only because the short end can't fall any further). Inflation expectations also fell slightly as well, along with commodities and the dollar. 

Personally I think the Fed announcement was underwhelming. Committing (whether loosely or strictly, no one really knows how serious they are about this commitment, or even whether it is a commitment at all - are they simply predicting they will need to do this?) to leaving rates at 2013 is another way of telling us that they predict a significant output gap will remain at least until then and won't take the necessary actions to do anything about it. Is there anyone who isn't thinking about Japan now?

The dissents are puzzling... if 3 members are going to dissent, why not do something more like lower interest on reserves? Maybe they would have had even more dissents if they did, if so, we are in serious trouble... if not, they obviously should have tried more. Christina Romer said the dissents might be a sign Bernanke is now more willing to work without unanimous approval of policies, but why not do more right now?

I don't blame markets for their "confusion"... I'm not really sure how to read this either. It was certainly better than nothing, but not much better. Much more stimulus is needed. Still, today once again demonstrated that markets don't buy either liquidity trap or easy money stories.

No Surprises Here - Let's Hope Bernanke Has Learned His Lesson

Stocks, commodities and long term bond yields all rose in response to Bernanke's testimony today. Expected fed funds rates fell, which suggests any more stimulus is more about postponing tightening than anything else.

If the Fed does need to engage in additional asset purchases (and I think it's extremely likely it will) it should use more flexible policies than it did in QE2. Instead of announcing in advance it will purchase $X in bonds over a certain time period, the Fed should purchase or sell (if the economy improves rapidly) as many bonds as it needs on a month to month basis in response to changing economic circumstances. This would allow them to seamlessly transition between tightening and easing as if they were controlling the fed funds rate.

Better late than never...

Fed Funds Trajectory - Before and After the Fed Annoucement

Fed Funds futures fell very slightly in response to today's speech and Q&A with Bernanke. Take a look at the response in other markets.

S&P 500

Before : 1347

After : 1357

Treasuries

2 year

Before : 0.66

After : 0.64

10 Year

Before : 3.35

After : 3.35

30 Year

Before : 4.42

After : 4.45

Inflation Expectations (based on 2 year inflation swaps)

Before : 2.66

After : 2.65

Bloomberg Commodity Index

Before : 1764.38

After : 1766.98

There's nothing shocking here because there was nothing shocking about the Bernanke's speech. Still, all of these moves are entirely consistent with the view that 1) The Fed can increase AD -- and that 2) Higher AD won't push prices significantly higher, even in the short run.

It's also worth noting that 30 Year Treasury yields rose 6.9 basis points today, while 30 Year TIPS rose 5.6 basis points. 10 Year Treasury yields rose 4.8 basis points and 10 year TIPS rose 4.5 basis points. That strongly implies that higher interest rates (as well as higher equity and commodity prices) are not a result of higher expected inflation, but of higher expected real growth.