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FOMC Minutes Confirm That “Tapering” Is Closer Than Expected

- Christophe Barraud


Last night, the FOMC published Minutes from October meeting. Even they did not provide specific insight into the timing of an initial tapering move, they suggested that (1) “tapering” will start in coming months even before an unambiguous further improvement in the outlook was apparent”, (2) Fed members considers equal cuts to MBS and Treasury Purchases, (3) Fed has yet to determine the best way to help further distinguish between tapering and tightening.


We could isolate some excerpts from the FOMC Minutes:


Participants reviewed issues specific to the Committee’s asset purchase program. They generally expected that the data would prove consistent with the Committee’s outlook for ongoing improvement in labor market conditions and would thus warrant trimming the pace of purchases in coming months. However, participants also considered scenarios under which it might, at some stage, be appropriate to begin to wind down the program before an unambiguous further improvement in the outlook was apparent. A couple of participants thought it premature to focus on this latter eventuality, observing that the purchase program had been effective and that more time was needed to assess the outlook for the labor market and inflation; moreover, international comparisons suggested that the Federal Reserve’s balance sheet retained ample capacity relative to the scale of the U.S. economy.

A number of participants believed that making roughly equal adjustments to purchases of Treasury securities and MBS would be appropriate and relatively straightforward to communicate to the public. However, some others indicated that they could back trimming the pace of Treasury purchases more rapidly than those of MBS, perhaps to signal an intention to support mortgage markets, and one participant thought that trimming MBS first would reduce the potential for distortions in credit allocation.


Participants discussed the financial market response to the Committee’s decisions at its June and September meetings and, more generally, the complexities associated with communications about the Committee’s current policy tools. A number of participants noted that recent movements in interest rates and other indicators suggested that financial markets viewed the Committee’s tools–asset purchases and forward guidance regarding the federal funds rate–as closely linked. One possible explanation for this view was an inference on the part of investors that a change in asset purchases reflected a change in the Committee’s outlook for the economy, which would be associated with adjustments in both the purchase program and the expected path of policy rates; another was a perspective that a change in asset purchases would be read as providing information about the willingness of the Committee to pursue its economic objectives with both tools.


Since the last FOMC meeting, several figures have showed that growth will be stronger than expected in H2 2013. Moreover, PCE inflation rebounded in Q3 and the October employment report was very strong. As a consequence, if the incoming data confirm the recent improvement and the Congressional budget committee finds a comprise concerning fiscal issues by Dec. 13, the Fed could decide to taper before the end of the year which is sooner than expected (March 2013).


Regarding the constitution of asset purchases, I think that people were surprised to read that the Fed could reduce both its Treasuries and MBS’ purchases in the same time. The fact is that MBS market is less liquid and impacts directly mortgage rates.

Existing Home Sales will be Higher than Expected in July

The NAR is scheduled to report July existing home sales tomorrow and the Bloomberg consensus is expecting 5.15 million units up 1.4% from June.


Yet, according to my friend, Christophe Barraud, Chief Economist and Strategist at Market Securities and also the best forecaster of US statistics since November 2012, existing home sales should rise sharply in July:


According to my estimate, in order for the sales in adjusted value to be stable from June to July, that is to say around 5 080 K – raw data should rise 16.2% from July 2012 to July 2013. Nevertheless, local data that I gathered show a rise of 20.8%. Indeed, even if existing home rose slightly in some regions like Las Vegas (1.2%), they increased significantly in some areas such as North Texas (28.0%). Finally, we get a seasonally adjusted statistics of 5 280 K which represents a 3.9% rise MoM.
This rebound in existing home sales was due to several factors:
1/ Inventories’ rebound: With the significant increase in prices, more and more households are no longer in a situation of “negative equity” and now want to sell their property.
2/ The recent rise in mortgage rates led buyers enjoying a rate-lock period of the borrowing rate to exercise their options.


This forecast is coherent with articles which show that sales rose YoY in some regions and therefore were far above the +16.2% threshold needed to stabilize sales in July:
- Clark County (+39.3% YoY)
- California (+21.8% YoY – the highest figure for a July since 2005)
- South Carolina (+23.6% YoY)
- Triangle (+34.3% YoY)

Federal Reserve Gave Six Signals that “Tapering” Will Not Start at its Next Meeting

On Wednesday, the Federal Reserve gave six signals that “tapering” will not start at its next meeting in September:


1/ It downgraded its view of economic activity, calling the pace of growth “modest” rather than “moderate”. The fact is that GDP publication shows that growth slowed significantly in H1 2013. Moreover, the Fed’s forecast for 2013, which was [2.3%-2.6%] in June, could not be achieved. As an example, the GDP should grow by 4% (QoQ annualized) in Q3 and Q4 to reach 2.6% in 2013. As a consequence, in September, the Fed committee will be obliged to revise sharply its growth estimate for 2013 and also the next coming years.


2/ The Federal Reserve noted that mortgage rates had risen, implicitly flagging this as a drag to the housing recovery which was one of the main driver of US growth last quarters.


3/ Inflation weakness became a concern of most Fed members. A subject that apparently secured the vote of St. Louis Federal Reserve Bank President James Bullard, who dissented in June over worries about deflation.


4/ Fed members did not give any guidelines about how the committee might adjust its purchases in response to economic developments. I expect that Fed committee will detail clearly its strategy before “tapering” because it wants to avoid any tensions on the financial market in a context where fiscal uncertainty remains.


5/ Once again, Fed members underlined that fiscal policy is restraining economic growth. I believe that lawmakers will not find compromise on the “continuing resolution” and 2014 budget until the end of September. Therefore, as I said before, the Federal Reserve will not create more uncertainty.


6/ Despite better labor market conditions, the Federal Reserve noted that “unemployment rate remains elevated”.


FOMC Statement:


Information received since the Federal Open Market Committee met in May suggests that economic activity has been expanding at a moderate pace. Labor market conditions have shown further improvement in recent months, on balance, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy is restraining economic growth. Partly reflecting transitory influences, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic growth will proceed at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall. The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective.
To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. 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. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Jerome H. Powell; Sarah Bloom Raskin; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action was James Bullard, who believed that the Committee should signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings, and Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations.

US Mortgage Rates Reached 12-Month Highs

Recently, some concerns appeared regarding the level of mortgage rates. Yesterday, Zillow recorded that this week, mortgage rates for 30-year fixed mortgages rose to 3.71% (up from 3.58% at this same time last week) and reached a 12-month highs. This movement occurred after ten-year Treasury bond rebounded above 2% amid speculation that the Federal Reserve could pull back on its bond-buying program before than expected. This idea was backed by Erin Lantz, director of Zillow Mortgage Marketplace:


“Rates spiked last week after meeting minutes revealed the Fed was contemplating scaling back economic stimulus plans much earlier than expected”


Remind that US central bank is buying $40B of MBS and $45B of Treasuries every month in an effort to reduce borrowing rates and that there is a strong correlation between the mortgage market and the US Treasury bond market. Indeed, holders of mortgage securities used to hedge the risk of declining MBS prices by selling US Treasuries.


Zillow data were confirmed by numbers which show a rebound in May of 30-fixed-mortgage-rates (almost 50 bp to 3.88%).



FT noted this sharp rise is also the result of a sell-off in the market for mortgage-backed securities as real estate investment trusts and portfolio managers had been active sellers. The article underlined that:


“MBS prices have tumbled to levels not seen in more than a year, and well below the level when the Fed began its latest round of purchases last September.”… “Further sharp falls on Tuesday sent the price of some recently issued MBS, which pay a coupon of 3 per cent, below a price of 101 of face value, down from a peak this year of nearly 105 in early May. The slide in price has eroded capital gains for investors, and added fuel to the sell-off. The most popular tranche of MBS, securities which pay a coupon of 3.5 per cent, have tumbled from a peak of almost 107 to below 104.”


Even if my view is that 10-year Treasury bond will not hit 2.40% before at least the end of the year (mainly because of moderate growth and low inflationary pressures) and will not push mortgage rates much higher, this move will affect immediately refinancing activity and then purchasing activity. Note that refinancing activity is already under pressure as Mike Fratantoni, MBA’s Vice President of Research and Economics said today:


“Refinance applications fell for the third straight week bringing the refinance index to its lowest level since December 2012 as mortgage rates increased to their highest level in a year”