Tuesday, August 10, 2010

Fed Update -What is the Fed really doing?

Fed Update – the FOMC decision/statement today delivered an unexpected surprise to the market as the Fed decided to reinvest maturing agency debt and agency MBS into longer-term Treasuries. While such a move had been talked about in the press for the last couple weeks, the Fed was not expected to take this course of action at today’s meeting. The other components of today’s decision were essentially inline and the tone around growth was actually a bit more sanguine than current market sentiment – the Fed said it “anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of recovery is likely to be more modest in the near-term than had been anticipated”. Once again, T Hoenig dissented, voting against both the “extended period” language when it came to rates as well as the reinvestment decision. The announcement hurt the dollar (the DXY was up close to 1% at one point today but wound up giving nearly all the advance back) and helped Treasuries (esp. 10s - 10yr yields fell ~8bp to 2.75%); stocks rallied initially, but the move was short lived as investors were spooked by the sudden change in Fed direction.

· What is the Fed really doing? Recall at the end of Q1:10 (end of Mar 2010), the Fed wrapped up $1.25T worth of MBS buys and $175B worth of agency debt. The Fed wrapped up the purchase of $300B worth of Treasuries in Oct 2009. However, since the end of Mar, the Fed’s asset purchases have gradually been shrinking due to maturities. The Fed today is saying that it will reinvest all maturing MBS and agency debt back into Treasuries so the aggregate size of its securities holdings are left unchanged (some had been complaining that this gradual shrinkage of the balance sheet amounted to small monetary tightening – that will stoop now).

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