Wednesday, December 18, 2013

Beginning the Taper: What Fed Policy Change?

The Federal Reserve announced today that it will begin to taper its purchases of Treasury securities and mortgage-backed securities.  Starting in January, it will purchase each month $40 billion of Treasuries and $35 billion of mortgage-backs, instead of $45 billion and $40 billion, respectively.  A $10 billion drop from $85 billion per month. Whoop-de-do.  That's barely a drop in the bucket.  Yet, after the announcement, the Dow Jones Industrial Average jumped almost 300 points.  A 1.84% increase in the Dow because of a reduction in central bank accommodation?  Financial news stories attributed the stock market rise to a belief that the Fed was signalling that the economy was improving faster than expected.  But there's a much simpler explanation for the exuberance in stocks.

The Fed said that it was likely to keep short term interest rates at zero for "well past" the time when unemployment fell below 6.5%, its previously announced benchmark for starting to raise short term rates.  This is a significant change from previous statements.  It means that the Fed will keep short term rates at zero for a really long time, and it's not saying how long.  Could be forever, since the Fed didn't announce a new unemployment benchmark for raising rates. 

The promise of ultra cheap money indefinitely is to stocks like pouring gasoline onto a fire--instant exuberance.  What the Fed did today was give back with the right hand what it took with the left, and then some.  It's fair to say that the Fed increased net central bank intervention today.  The sharp jump in stocks is consistent with that view.  The relatively minor change in bonds is as well.

But are we surprised?  Did we really think the Fed was going to step out of the picture in a meaningful way?  American businesses and investors have become addicted to heavy doses of monetary methadone from the central bank.  If the Fed began to actually step back, the market would have tanked. 

What happened today is the Fed switched from wearing a blue tie to a paisley tie.  But the change was cosmetic, and net result was more Fed accommodation.  Oh, well. Plus ca change, plus c'est la meme chose.

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