In a largely anticipated move, the Fed Reserve kept interest rates unchanged on Wednesday. The Fed avoids shocking the markets by sticking to a well-rehearsed script. The huge bond-buying stimulus scheme that has propped up the economy and, in particular, equity markets since the pandemic began is coming to an end. The Fed, on the other hand, is adamant about getting good value from the temporary printing press, as it adheres to its oft-stated belief that inflation will be temporary.
At the very least, they acknowledged that it could be temporary for a longer period if that makes sense! Powell stated, “Inflation is elevated, mostly reflecting causes that are considered to be transitory.”
“Indicators of economic activity and employment have continued to improve as a result of success on vaccines and strong governmental support.” On a lighter side, when asked to clarify transitorily, Fed Chair Powell said it doesn’t leave a permanent impression on prices and inflation. This is the litmus test, and the stock market believes the Fed is not behind the curve thus far. The currency and bond markets, on the other hand, are less certain.
The Fed plans to acquire $60 billion in Treasuries and $30 billion in Mortgage-Backed Securities in December (MBS). That’s a difference of $10 billion in Treasuries and $5 billion in MBS. Still, a lot of thinking has gone into this taper, so proceed with caution.
The stock market reacted strongly, as it always does. This juggernaut isn’t going to be deterred by any news, and a timid and well-flagged taper isn’t going to help. The dollar has also struggled to find a direction after the decision, oscillating at 1.16 but currently dropping marginally. With the curve steepening, US rates rapidly jumped, but this has now subsided, with 2-year yields remaining unchanged at 0.47 percent, 10-year yields at 1.57 percent, and 30-year yields at 1.98 percent.
Overall, the Fed has taken a steady and cautious approach, with the possibility of going too far behind the curve all but eliminated. Equity markets are approaching new all-time highs, while VIX, a measure of equity market volatility, is sliding to the low end of its current range around 15. MOVE, a measure of bond market volatility, has also fallen, but it is now higher than it has been in the recent past, implying that the bond market and the Fed are set to fight. Risk is on for equity investors, which means greater gains are probable.
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