The Fed gives the Street a headfake
Wednesday, Ben Bernanke gave the street a headfake as the Federal Open Market Committee decided to keep asset purchases in place. Ever since the June meeting, where Bernanke introduced the possibility of a Fed taper, rates increased as investors de-leveraged and unwound their curve-flattening trades. Foreign investors have been net sellers of U.S. financial assets as well. The Street was expecting the Fed to announce at least some sort of reduction in asset purchases at the September meeting. As you can see from the above chart, the Street was extremely surprised by the Fed’s non-action and the yield dropped over 20 basis points over the course of the afternoon, which is an enormous move for the ten-year treasury.
Watch the data, he said
How did the Street get it so wrong? Almost everyone had predicted some sort of reduction—the consensus was anywhere from $10 billion to $15 billion per month, with the bulk of that concentrated in Treasuries. Ben Bernanke’s language previously was that the Fed expected unemployment to gradually reduce over the course of the year, and if that happened, he expected the Fed to begin to unwind asset purchases. Well, we’ve seen unemployment falling steadily this year, although for the wrong reasons (a dropping labor force participation rate). Granted, the other data has indicated a bit of a slowdown, but unemployment has played out pretty much the way the Fed has forecast. (In fact, the Fed took down its estimates for unemployment—more on that later.) Suffice it to say, there are a lot of angry journalists and strategists out there. Although Bernanke has said the FOMC would be guided by the data, he did lay out a roadmap of what to expect.
So what changed?
The U.S. economic data has been unspectacular this summer. Nothing great, nothing terrible. In fact, it’s slightly better than it was during the spring. For all the hand-wringing about the sequester, about the only people who noticed aside from some government workers were the luxury car dealers at Tyson’s Corner. Actually, it was probably the housing sector that changed the game. In almost every economic recovery, housing is the first sector to strengthen, and it’s the engine that pulls the economy out of the ditch. This time around, that didn’t happen, as the real estate sector was still recovering from the bubble years. As rates have risen, housing starts have fallen off and we’re seeing a drop-off in traffic—at least at the lower price points. Builders like PulteGroup (PHM) and Beazer Homes (BZH) noted this phenomenon. At the higher end—think Toll Brothers (TOL), NVR (NVR), and Meritage (MTH)—there has been less of an effect. Housing affordability has been hit by three big factors—an increase in interest rates, an increase in house prices, and an increase in insurance premiums. The Fed was probably worried enough about the housing sector that it decided to keep the status quo.