What’s next in post-QE world?

September 16, 2014 11:35 AM

Markets are setting up for a change in wording in the September FOMC statement, to be released after the Sept. 16-17 FOMC meeting, by pushing fixed income prices lower. In December 2013, the Fed announced the beginning of the tapering process, $10 Billion per month to come off at each meeting and in September would take the final $15 Billion off ending the program in October. With QE finished the Fed now has to outline their plans going forward. Will there continue to be reinvestment of the QE bonds that roll off, what many expect or will market conditions decide that. The use of “considerable time” being taken out or change is a hot topic. We all remember Janet Yellen’s “six-month” comment that for a time quantified “considerable time” and rocked markets. The Fed does not like it when markets react like that.

The September meeting is also a meeting that the Fed includes their economic projections, these have proven attract much debate as well. Last week the San Francisco Fed published a piece that hinted that markets were pricing in a more dovish forecast than Fed projections, was this a shot over the bow? Curiously timed, the Kansas City Fed released a new labor conditions indicator (LMCI) made up of data from 24 currently used employment data points with measures of momentum and level of activity. Will the statement refer to these as a way to provide transparency?  

The past week interest rates have steadily risen, prices higher. Economic news has continue to show an economy that is improving but at a slow pace. On Friday, Retail Sales came in pretty much as expected but the details seemed to be enough some of the larger banks to revise GDP expectations for the 3rd and 4th quarter higher. Goldman and BofA also pulled their expectations for the start of Fed tightening from the 3rd quarter of 2015 into June of 2015. They weren’t the only ones, all week the Eurodollar pit featured large bearish options plays in the Eurodollar March 20 15 and September 2015 contracts. The pressure has been also felt in the bond contract, on Sept. December bonds was printing above 140-00, on the close Friday it was printing below 136-00. It was also pointed out to me that until this week the last 30-year monthly bond auction had finished their week in the money, is this week’s failure to do a sign?

As a side story, there were headlines on the screens Friday that Bernanke made hawkish comments during a private speech in London. He commented that he was optimistic about growth citing pent up demand and calling the slack in employment the result of a cyclical decline in the participation rate. Talk is that is what trigger Friday move lower in rates.

Market wise, changes in Fed policy always provide an increase in volatility and in most cases changes in long term trends. The question is, is this the meeting that the Fed signals a change? On charts it looks like fixed income markets are making a commitment to the change with sharp moves lower, there are plenty of ways to express trades in agreement or to play contrarian.  

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