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FOMC Statement and Market Impact

06/21/2012

Yesterday, the Federal Reserve Open Market Committee (FOMC) announced it will extend Operation Twist through the end of 2012. The FOMC will sell $267 billion worth of Treasuries expiring within the next three-and-a-half years while buying the equivalent amount in longer term debt with expirations ranging from six to 30 years.
 
Within its statement, the FOMC cited “significant downside risks” to the economy and aggressively lowered the forward looking economic forecasts. I expect the committee has positioned itself to “ease further” via unconventional tools if growth and labor slow further in July. A Friday, July 6, U.S. Labor report similar to June’s +69,000 dud will motivate the FOMC to act. I suspect a labor figure north of +175,000 is needed to give the FOMC pause on August 1, the date of the next FOMC meeting. If a “hard stop” exists for Chairman Bernanke in terms of enacting further monetary policy that would not be perceived politically, August 1 is the date.
 
While some viewed the FOMC results as disappointing and less dovish than expected, they are consistent with the recent Beige Book findings (please read my June 8 blog, “Bernanke Must Have Read the Beige Book”). I also believe the FOMC’s economic outlook in April was far too optimistic and needed to be lowered toward a realistic assessment of the current, modest U.S. economic growth. I am, however, disappointed that the Fed did not target the MBS market to provide support to a housing market that remains a major U.S. headwind.
 
Market Strategy: The implication for the market is really a “currency effect.” I do not see yesterday’s announcement reversing any of this year’s upside momentum for the U.S. Dollar (Figure 1.1), which may be a headwind for the upcoming July corporate earnings season. Additionally, it will not provide support for the commodity sector, specifically oil (Figure 1.2). 
 
FOMC June Economic Projections
 
•   2012 Real GDP was revised down from April’s 2.4%-2.9% to 1.9%-2.4%
•   2013 Real GDP was revised down from April’s 2.7%-3.1% to 2.2%-2.8%
•   2014 Real GDP was revised down from April’s 3.1%-3.6% to 3.0%-3.5%
 
•   2012 Unemployment Rate was revised higher from April’s 7.8%-8.0% to 8.0%-8.2%
•   2013 Unemployment Rate was revised higher from April’s 7.3%-7.7% to 7.5%-8.0%
•   2014 Unemployment Rate was revised higher from April’s 6.7%-7.4% to 7.0%-7.7%
 
•   2012 Core PCE Inflation was revised down from April’s 1.8%-2.0% to 1.7%-2.0%
•   2013 Core PCE Inflation was revised down from April’s 1.7%-2.0% to 1.6%-2.0%
•   2014 Core PCE Inflation was revised down from April’s 1.8%-2.0% to 1.6%-2.0%
 
Figure 1.1 U.S. Dollar Year to Date

Source: Bloomberg
 
Figure 1.2 Crude Oil Year To Date

Source: Bloomberg

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