FOMC: Inflation Still Transitory. QEII to End as Planned
Plain and Simple: The Fed acknowledged that inflation has picked up recently but is still expected to be "transitory". Thus rates will be kept low for an "extended period". With a tiny text change from "intends" to "will", the Statement essentially confirmed that QE2 will finish by the end of June . No indication was given that the Fed would discontinue the reinvestment of MBS portfolio prepays though, which maintains the size of their balance sheet ( = dovish). There were no dissenters. That was a concern of ours given the increase in hawkish rhetoric from voters Fisher and Plosser in recent months. One adjustment to the text that gives us an idea of just how mixed the Board's feelings are toward the big picture was removal of this apprehensive verbiage used in the March statement, "suggests that the economic recovery is on a firmer footing". The word "suggests" indicates uncertainty and keeps the door open for the Fed to downgrade their economic projections. This month the text was altered to read "indicates that the economic recovery is proceeding at a moderate pace". To us the removal of "suggests" was a very very subtle upgrade to the Fed's confidence but it definitely leaves the option on the table for "long slow recovery" rhetoric to enter the Fed Statement down the road.
There were three noticeable changes made to the Statement.
Here is the first difference....
APRIL STATEMENT: Information received since the Federal Open Market Committee met in March indicates that the economic recovery is proceeding at a moderate pace and overall conditions in the labor market are improving gradually
....vs....
MARCH STATEMENT: Information received since the Federal Open Market Committee met in January suggests that the economic recovery is on a firmer footing, and overall conditions in the labor market appear to be improving gradually
Here is the second difference...
APRIL STATEMENT: "Inflation has picked up in recent months, but longer-term inflation expectations have remained stable and measures of underlying inflation are still subdued."
....vs....
MARCH STATEMENT: Nonetheless, longer-term inflation expectations have remained stable, and measures of underlying inflation have been subdued.
Here is the third difference...
APRIL STATEMENT: "...will complete purchases of $600 billion of longer-term Treasury securities by the end of the current quarter"
....vs....
MARCH STATEMENT: "....intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011"
All other adjustments were insignificant in our opinion. For example: "are currently putting upward pressure on" was changed to "have pushed up inflation". And "will adjust those holdings as needed" was modified to read "is prepared to adjust those holdings as needed".
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HERE IS THE TEXT OF THE APRIL FOMC STATEMENT...
Information received since the Federal Open Market Committee met in March indicates that the economic recovery is proceeding at a moderate pace and overall conditions in the labor market are improving gradually. Household spending and business investment in equipment and software continue to expand. However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed. Commodity prices have risen significantly since last summer, and concerns about global supplies of crude oil have contributed to a further increase in oil prices since the Committee met in March. Inflation has picked up in recent months, but longer-term inflation expectations have remained stable and measures of underlying inflation are still subdued.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The unemployment rate remains elevated, and measures of underlying inflation continue to be somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Increases in the prices of energy and other commodities have pushed up inflation in recent months. The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations. The Committee continues to anticipate a gradual return to higher levels of resource utilization in a context of price stability.
To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and will complete purchases of $600 billion of longer-term Treasury securities by the end of the current quarter. The Committee will regularly review the size and composition of its securities holdings in light of incoming information and is prepared to adjust those holdings as needed to best foster maximum employment and price stability.
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.
The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.
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Market Reaction...
Knee jerky at first. "Rate sheet influential" MBS coupons are stable right now though. The FNCL 4.5 is -4/32 at 102-13...which leaves us 2/32 off intraday price highs but still below yesterday's close. In my model the secondary market current coupon outperforming benchmarks, the street should have similar observations as implied vol is once again deflating. Here are my marks: CC +1.6bps at 4.097%. +74.4bps/10yr TSY vs. +77.1bps/10yr TSY at 5pm yesterday. +69.1bps/10yrIRS vs. +72.1bps/10yrIRS at 5pm yesterday.
NEXT EVENT: Bernanke press conference at 2:15pm. You can watch it live on CSPAN