Hawkish or Dovish?
Was the FOMC statement Hawkish or Dovish? I think the market is as puzzled as some economists, even CNBC economics reporter Steve Liesman (Keynesian) was puzzled. The market reaction was muted for the most part and I think needs to adsorb what was said and then also look what has changed (if anything). For the most part it seems this FOMC statement was more about headline and optics, with out any real meat. In fact one addition to the FOMC statement was an exercise in the fallacy of circular logic, which only added to more confusion as to whether the Fed is becoming more Hawkish or Dovish.
Hawkish or Dovish?
We are now in a realm of semantics, which blurs reality and creates some interesting optics. I appreciate and I believe regardless of your economic school of thought or political persuasion, the Fed wants to and tries to move in baby steps as to not jolt the market, the dollar, or economy. I also believe the Fed wishes to wind down their “sizable” balance sheet and get back to something more normal. However, they can’t – not mathematically, regardless of the economic data. The interest on the debt alone and the need to find buyers of bonds overshadows any good news the economic data brings. You can’t find buyers of bonds unless you raise rates and you can’t raise rates without increasing the deficit, based on interest on existing debt. Check-mate, so the Fed has reverted to optics (FOMC statements) rather than any real changes to monetary policy.
What is Quantitative Easing (QE)?
Definition: An unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.
What defines the ending of QE3 is not the ending of the purchasing of financial assets, but rather the ending of the increase of the monetary base (money supply).
By the fed’s own admission in their FOMC statement, they are NOT ending the purchasing of assets:
“The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.“
This is an important distinction, because on one hand they are not ending their purchasing program and therefore not winding down (reducing) their balance sheet. So technically QE exists without the increase of money supply. True, the Fed is not increasing money supply, but they are also not decreasing it, but they are maintaining their asset purchases.
Some questions to ask:
Is the purpose of QE to expand the monetary base or is the expansion of the monetary base a byproduct of the need to purchase assets to reduce interest rates?
Would it still be considered QE if the Fed already HAD a “sizable balance sheet” of maturing bonds which they could draw upon to purchase more assets?
As you can see we can quickly get into a semantics argument, if we ignore the fundamentals of what the Fed is actually doing (purchasing assets).
Let’s look at some numbers:
The Fed has over $2.3 trillion in U.S. bonds with the following maturities.
Courtesy of ZeroHedge
About $200 billion will be maturing in 2015, which comes out to $16 billion a month (average of course) so they have lots of room to roll bonds (debt). Will $16 billion a month be enough to maintain purchasing power in the bond market? If rates stay in the sub 2.5% range, I doubt it. Couple that with government deficit spending and it looks like QE4 or some other accommodation will be needed. I don’t suspect anything until 2015.
It is this part of the FOMC statement that some (perhaps many) consider an implication for a more Hawkish Fed and thus the possibility of raising rates sooner. For myself, it was also the only real shocking change to the FOMC statement. Not only was I surprised, I will be the first to admit and humble enough to state I was wrong in my expectations.
Why was this such a surprise for me and in fact to others (including ironically CNBC economist Steve Liesman)? Because in the last FOMC statement, including the minutes and even Janet Yellen’s speech just last month, the Fed remain very concern about the significant weakness in the labor market. Remember the Fed is so concern about it they even dropped the U3 unemployment rate as a target for making monetary policy decisions.
Janet Yellen’s press conference in September after the last FOMC meeting she addresses that concern and states; “there STILL is and the statement says it … SIGNIFICANT underuntilization in labor resources and a very modest pace of wages which has picked up very little.”
Courtesy of wikipedia
However, since the last FOMC statement, the minutes, and her press conference, the labor market (other than the U3 which the Fed no longer uses as a target) has not improved. In fact by Yellen’s own economic data she addressed in her last press conference, wage growth, was actually DOWN in October. So what gives?
So the change in the FOMC statement from :”there remains significant underutilization of labor resources” to “underutulization of labor resources is gradually diminishing” was seen as being Hawkish by the market and that translates to an assumption the Fed will raise rates sooner rather than later. Yet I am not sure how Hawkish we should take it, because the language (while changed) did not remove concern about the labor market, it just stated that their concerns are “gradually diminishing”.
They did raise concerns about the disinflation or what some economist and pundits would rather call “deflation”. The minutes from the last FOMC meeting quoted concerns of a strong dollar and the impact it will have on GDP growth. They added to the statement; “Inflation has continued to run below the Committee’s longer-run objective. Market-based measures of inflation compensation have declined somewhat.” Which is inline with my expectations and has keep the door open for longer-term ZIRPing.
Courtesy of shadowstats
As expected they announced the end of QE3. They added justification for ending the QE by starting the paragraph that the Committee has seen substantial improvements and giving credit to their QE program. Yet, as I stated in the beginning, they are NOT ending asset purchases and using their “sizable levels” balance sheet to fund future asset purchases. So I guess this is more window dressing, because they are not actually reducing or winding down their accommodation at all, they are just not adding to it. It is a step in the right direction as I fall in the Hawkish camp, I am just not sure if they will maintain such a position in the long run, if the market comes under pressure and/or the dollar continues to rally, thus creating “disinflation” or “deflationary pressure”.
Courtesy of FRED
Now the biggest change which left something for both the Hawks and Doves to chew over was an addition to the FOMC statement at the end. Actually I think it added more confusion and less clarity and you will certainly hear the Doves and Hawks spin it to their likening.
However, if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.
Has the Fed mastered the fallacy of circular reasoning? If economy improves we will raise rates, conversely if it doesn’t we will keep it at zero. Clearly they are feeding both the Hawks and the Doves. The Hawks will only read (out of context) “likely to occur sooner than currently anticipated.” and the Doves will only read (out of context) “target range are likely to occur later than currently anticipated.”
What was interesting was seeing Plosser and Fisher voting with the policy statement. To me they were most likely appeased in the employment improvement language and having the last new paragraph added (to get them on board). I was surprised to see Dove Kocherlakota vote against it, but I guess any mention of rate hikes would get a “no” vote from the more ardent Doves.
Equity Market: Saw a little volatility and came under some pressure, but the FOMC was not too Hawkish to cause a panic and not too Dovish to cause a rally. The end of QE was expected, but the Fed is still purchasing assets and is not clear if they are going to raise or lower rates.
VIX: It held up and move back in the 15 range as there is still some wondering what to make of this. Was it Hawkish or Dovish?
Bond Market: We did see a slight rise in the 10-year yield, up to 2.32% – but held below 2.4% Clearly the end of QE3 does not mean an end to bond purchases. As the Fed continues to buy bonds, I don’t see the rates going up.
Dollar Index: The dollar index rallied slightly, back to the 86 level.
Gold: Gold was hit fairly hard as the dollar rallied, getting back into the low 1200 range.
Oil: Oil actually moved slightly higher into the $82 range. However I think it will stay in the low 80s for now.
The mainstream media only grabbed onto the headline, QE ENDS and the Fed said the economy is improving. That bodes well for the Democrats in the mid-term – economy improving, cheap gas prices, ending of Fed QE. Seems like this was more about optics then actual economic data.
It would seem that the FOMC statement was just right for the market and for the mid-terms. As I pointed out yesterday the perfect statement would keep the market aloft, rates low, oil low, dollar strong, and bring forth optimism about the economy. It seems that is just what it did and avoided bringing forth volatility. I was surprised by the change in tone in the employment picture, but in hindsight am I really? Not if it was intended to create better optics, despite the actual data contradicting Yellen’s concern.
I will probably catch flak for this, but I think the Fed’s position hasn’t changed one iota. The changes to the text about employment improving after the data reflects the contrary seems more about either justifying an end to QE3 or helping boost the mid-term optics or perhaps both. The addition of “if the economy improves we will raise rates, but if it doesn’t we will lower rates” just shows they are leaving the door open. The fact that they have added that they will be using their “sizable” balance sheet to continue to buy bonds to remain accommodative tells me that nothing has really changed.
We know the Fed is trying to elevate inflation and has set a target of 2% (or 2.5%) and right now with the ECB and BOJ we are in a disinflation environment. What is insane is that if we are in a disinflation environment (or “deflation pressure”) while running ZERO interest rates, then where can the Fed go from here if they want to spur inflation? Negative Rates, QE4, or something new?
I am certain the Fed will not sit idle while the dollar rallies, causing disinflation and weakness in exports, and a trade gap widening. Sure they could let it go through their December meeting and perhaps into the new year, but at some point they will act because they will have to or feel obligated to. We can’t forget that the entire ongoing ZIRP and QE program is to create inflation and keep rates low, not disinflation (or perhaps deflation) or a rise in rates.
This FOMC statement was crafted just right – to give everyone something to chew on without really changing policy. It also didn’t rock the mid-term vote. Yet the Fed will not keep idle as the devaluation currency war continues to heat up, which will impact trade, exports, and eventually their largest concern – domestic manufacturing jobs.
It wasn’t too dovish and it wasn’t too hawkish, it was just right.
Support & Resistance
I think the market needs to absorb the FOMC statement a little and hopefully realize that nothing has really changed. We could get some selling pressure if the market assumes a more hawkish tone. 17,000 is a straddle strike and I think we can get to 17,200 prior to the mid-term election. I wouldn’t look for a strong rally for the rest of the year any more than I would look for a correction just yet. I think we are in a consoldiation period, which if no outside forces disrupt the market, could remain into the holidays.
The highly volatile and tech heavy index has made a nice rebound, however I don’t think volatilty in this index has left the station. I bbelieve a visit back to 3950 or higher to 4150 is in the cards in the short-term. A few heavy weights in this index has certainly driven it both higher and lower.
I think we can still get to 2000 by the mid-terms, but we are consolidating and the VIX looks like it will hold in the 15 range for now – waiting to determine if this FOMC statement is dovish or hawkish. I think the market still is uncertain.
I continue to watch the RUT as my guide to general market order flow. It looks like it is consolidating and the message between the GDP release and the Hawkish/Dovish FOMC statement has it in a consolidation range right now. 1160 is in th cards, but so is 1120.
3rd Quarter GDP came out far better than expected at 3.5%, above the 3% expectation by economists. While the headline looks great, consumer spending came in weaker. The big surge was defense spending, the fastest pace since 2009 and was one of the largest contributing factors to economic growth. The pace of growth in business investment, housing and consumer all slowed in the quarter. Supposedly two thirds of growth comes from consumers, which saw growth decline to 1.8% pace down from 2.5%. This contributed 1.2% points to the 3.5% GDP.
Weekly jobless claims increased 3,000 to a “seasonally adjusted” 287,000, which came in slightly worse than expected as we are entering the holiday hiring sales season.
While these two data points were not bad, they certainly were not great and some of the data within the GDP were a little concerning with the weakness in the consumer, housing, and business.