Wednesday afternoon, October 9, the Federal Open Market Committee (FOMC) released the minutes from its September 18-19 meeting. Also Wednesday afternoon, President Obama nominated current FOMC Vice Chairman Janet Yellen to be the next FOMC chairman. Both of these events occurred as the S&P 500® Index (SPX) (Figure 1) continues to correct from its post-FOMC meeting all-time high of 1729.86 on September 19. The correction now stands at 4%, with the next major technical support level found at 1630.
Figure 1 S&P 500 Index (SPX) 2013
As expected, the FOMC minutes do not provide any clarity as to the timing of asset purchase moderation. However, the minutes offer some messages that investors must consider:
- Consistent with my expectation, once the tapering process begins, the minutes seem to indicate that the asset purchase moderation will only impact Treasuries and not mortgage-backed securities. The minutes indicate the FOMC remains highly sensitive to the housing recovery and is focused on not disrupting that recovery.
- Clearly the FOMC follows the direction of the markets, in particular Treasury yields (Figure 2). Those that supported “no taper” in September included the tightening of financial conditions from rising interest rates to support the “no taper” platform.
- The FOMC’s credibility was mentioned as a rightful concern, citing market expectations for September tapering and the postponement of an announcement having “significant implications for the effectiveness of committee communications.”
Figure 2 U.S. 10-Year Treasury Yield 2013
Earlier this week I posted the blog “Q3 Earnings, The Real Catalyst.” After reading the minutes and listening to several Fed presidents’ comments this week, I am convinced the upcoming earnings season will be incredibly important for both the market’s direction and to an extent satisfying the economic data void the government shutdown is forcing.
On Tuesday, October 8, Philadelphia Fed President Charles Plosser stated “the Fed is not really flying blind” without economic data from the government. Anecdotal evidence can be received in particular “from the private firms.” Investors must pay attention to the upcoming earnings season, and the real earnings season begins Friday morning with J.P. Morgan (JPM) and Wells Fargo (WFC). I would argue that even with a resolution in D.C. on all fiscal issues, a solid earnings season will be needed to revert the SPX back to its prevailing trend and target the September 19th all-time high of 1729.86.
I also suspect that, as I have previously blogged, consideration was given to the impact of rising U.S. Treasury yields on the emerging markets. The current Fed vice chairman is widely regarded as the emerging markets biggest ally on the FOMC. In fact, today central bankers from both South Korea and Indonesia applauded Janet Yellen’s appointment and her understanding of the capital flow impact a potential U.S. bond purchase taper would have on emerging markets. IMF Director Christine Lagarde said she was “overjoyed” with the Yellen nomination. India went so far as to state the Yellen appointment gives “much needed extra time” to narrow its current account deficit. Policy makers outside the U.S. seem more excited about the Yellen nomination than our own U.S.-elected officials.
Back on September 19, my expectations for FOMC tapering were proven incorrect. For those who argue the FOMC did the right thing by postponing its announcement in anticipation of a U.S. government shutdown, that may be correct in theory, but from a practical standpoint, the market has proven it is flawed. Since the September 19 “no taper” decision, the SPX has continually corrected lower. The FOMC minutes clearly highlight that the committee pays attention to the markets. I suspect the lower SPX price action that began in the days following the “no taper” announcement is evidence that the impact from continued stimulus on risk assets is muted. The credibility of the FOMC, as some committee members raised concerns about in the minutes, is the larger issue.
Let’s hope the economic data over the coming months prove “Two Plus Two Equals Four” and the FOMC tapering can begin. Otherwise in September the FOMC might have missed as good an opportunity as it will get to start the process.
There remain two FOMC meetings in 2013, the first on October 29-30, which does not include a post-statement press conference. Logically, the timing of the government shutdown suggests there will be no tapering at the October meeting. Additionally, some recent economic data such as the ISM Non-Manufacturing report did moderate, with a 54.4 September reading reported on October 3, below the previous month’s 58.6. The FOMC will pay attention to that services sector moderation.
More likely, the last FOMC meeting of the year, on December 17-18, will be when the tapering process begins. The December meeting does include a post-statement press conference, which would be the optimal time for current Chairman Ben Bernanke to convey his final messages.