Must-know outlooks from the December FOMC meeting

Must-know: The Fed finally tapers QE, but it also eases the pain

Ben Bernanke’s parting shot

Yesterday, the Federal Reserve ended its Federal Open Market Committee meeting and decided to taper. It will reduce purchases of Treasuries by $5 billion a month and purchases of mortgage-backed securities by $5 billion a month, which means the Fed will continue to build its balance sheet by $75 billion a month instead of by $85 billion a month. Tapering will begin in January. This was Ben Bernanke’s final FOMC meeting as Chairman before the torch passes to the “dream team” of Janet Yellen and Stanley Fischer. Bernanke’s final press conference was no victory lap, but the press was respectful.

Fed AssetsEnlarge Graph

Market reaction

Bonds initially sold off on the news, with the ten-year trading above 2.92. Then bonds rallied, and the yield dropped to 2.82%, and then finally bonds sold off, with the yield ending the day at 2.89%. Stocks loved the report, with the S&P 500 rallying 33 handles to close the day at a record high. Mortgage-backed securities were off by almost half a point.

Is this the first in a series of moves?

Steve Liesman of CNBC asked this question, and it seems that the Fed will reduce asset purchases by something like $10 billion every meeting from now on. Bernanke mentioned all of the caveats about being data-dependent, but it looks like this will be a constant until the Fed is no longer purchasing assets. The Fed will continue to reinvest maturing proceeds back into asset purchases. Ben Bernanke stressed that the Fed’s balance sheet is still growing, but it just isn’t growing as fast as it was. Bernanke was asked if that meant the Fed would likely still be conducting asset purchases in mid-2014 (as was the previous guidance), and he said QE would probably end in late 2014.

The Fed eases the pain a little

The Fed changed the language regarding how long rates would remain close to zero. Previously, the Fed had guided an unemployment target of 6.5% as the level it would start raising interest rates at. That language was changed to, “The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.” That language was what the stock market focused on, and it probably accounts for the rally.

Implications for homebuilders

For homebuilders like Lennar (LEN), KB Home (KBH), Standard Pacific (SPF), PulteGroup (PHM) and Toll Brothers (TOL), this means that mortgage rates are going to rise. As mortgage applications continue to fall (today the Mortgage Bankers Association Mortgage Applications Index dropped to its lowest level since 2001) the Fed’s footprint in the TBA market got bigger and bigger. It made sense to lower the Fed’s impact on the MBS market.

Rising mortgage rates are not helpful for the builders, but they’re not the only thing that matters. As the economy improves, they will get increased traffic as people’s financial situations get better. We recently saw that household net worth increased by something like $1.9 trillion over the past quarter. This will matter much more to the builders than 30 or 40 basis points on the 30-year fixed-rate mortgage.

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