The Fed’s Humphrey-Hawkins testimony and its implications for REITs (Part 3)

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The Fed’s comments on monetary policy

The Fed received a number of complaints regarding the move in interest rates over the past couple of months. Many members of Congress were alarmed at the increase in rates, and many worried that it would dampen the recovery. Bernanke referred to the June comments and said that the intent was to provide additional information and not to communicate a change in policy. Two points came out of the discussion that were somewhat new and very relevant.

The biggest point concerned how the Fed would manage its portfolio of Treasuries and mortgage-backed securities once quantitative easing ended. Most participants assumed the Fed would not end up selling its inventory back into the market and that it would simply allow the portfolio to roll off naturally. This means that it would let the securities mature and hold the cash. Bernanke confirmed that the Fed intends to hold its stock of Treasury and agency securities off the market, but it will also “reinvest the proceeds of maturing securities, which will continue to put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.”

The second point concerned the Fed’s view of what caused rates to increase so drastically. First, Bernanke said he believed the economic data was getting better and that was a reason for the stark rise. On its face, that’s true, but the economy has hardly gotten much better. He also mentioned that many market participants were unwinding levered positions. While not mentioning REITs by name, they surely were one of the participants he was referring to. This effect was “unwelcome,” but it did reduce risk in the system.

Bernanke also softened his stance that the default path was for the Fed to begin tapering quantitative easing this year. He said that the pace of bond purchases wasn’t “on a preset course and he sees highly accommodative policy in the foreseeable future.” This was interpreted by the market as dovish (not aggressive), and yields on the ten-year dropped about seven basis points on that comment. He also reiterated that these guideposts were “thresholds, not triggers” and that if unemployment dropped for the wrong reasons (like a lower labor force participation rate), then the Fed would be willing to delay the taper or even temporarily increase purchases. He said the language “at least as long as” was meant specifically to reinforce the point that these guideposts are thresholds and not triggers.

Continue to Part 4