MBS RECAP: Fed's Tricky Statement Lets Markets Choose Their Own Adventure

Today's FOMC Announcement and ensuing press conference caused significant volatility (albeit, within a historically narrow range) for bond markets.  One of the main reasons for the initial volatility is that the traditional methods of quickly sorting through the changes in the statement were more or less "broken" by the way the Fed put it together.  It resulted in computer programs thinking there was an entire paragraph missing (the one that included "considerable time"), and an entirely new paragraph created (also with "considerable time!").  It ended up being easier to go old-school in examining the differences, so I slapped both statements on the same page and drew the following picture for you (click to make it big enough to read):

Even that method ended up being fairly confusing and the trading reaction bore that out.  Levels were up and down following the statement, but traded blows relatively evenly for the first 30 minutes.

Here's more on how the statement "broke" algorithms--the electronic programs that instantly read the Fed text (or other news) and spit out actionable information (like the kind that traders might want to use to react to the Fed!).  These particular text-reading programs go word by word and assess whether or not each word is new, missing, or the same.  So when they got to the the third paragraph, things really got messy because the new third paragraph was completely different than the old third paragraph.  But text readers did their robotic jobs and pointed out the differences. Only a few of the generic words were shared in both past and present versions.

The trick was that the new third paragraph is essentially the old fourth paragraph!  Since the text readers had already processed the words in the new third paragraph, the old fourth paragraph now had no remaining counterparts in the new statement (they'd already been "used" in the stupid comparison to the old 3rd paragraph).  As such, text readers assumed the entire old 4th paragraph was gone (look at the sea of red and green in the WSJ version as the algo assumed massive deletion and massive new insertions).

Unfortunately, that 4th paragraph in the old text included the phrase everyone was looking for: "considerable time."  This resulted in unfortunate wires such as:

RTRS- FED DROPS 'CONSIDERABLE TIME' PHRASE IN RATE GUIDANCE, SAYS IT CAN
BE "PATIENT" IN BEGINNING TO NORMALIZE THE STANCE OF MONETARY POLICY

It didn't take markets long to realize that "considerable time" was still in the statement--just in a different place--which probably accounts for the initial move lower for rates.  It also didn't take long for market participants to see the Fed was equivocating a bit by mentioning "considerable time" as something they said in the last statement, and instead saying that the current statement is merely "consistent with its previous statement." 

Huh?  What are they trying to do there?  Say it, but not really say it?  This created more confusion.  Markets reacted accordingly with more knee-jerkiness.  Ultimately though, this wording is very clever because it allows readers to think whatever they want to think about whether or not there is still a "considerable time."

Miraculously (or 'unsurprisingly?'), bond markets were precisely in line with pre-FOMC levels by the time Yellen began her press conference.  Here's where the Fed removed some doubt as to its outlook on rate-hike timing.  The most significant statement in the prepared remarks was Yellen saying the Fed was "unlikely to begin the normalization process for at least the next couple of meetings."

If you know the Fed, you know that "couple" is absolutely different than "several" or "a few."  Indeed, when asked about this later by NY Times' Applebaum, Yellen clarified that "a couple" refers to "2" according to the dictionary.  So the Fed's first conceivable rate-hike meeting--all other things being equal--would be at the end of April 2015.  Of course Yellen said it could be later than that, depending on conditions, but at that point, who's really listening? 

That interaction, combined with a relative dismissiveness concerning the impact of low oil prices (she referred to it as a net-positive for the economy) was all that bond markets needed to hear. The Fed isn't much concerned about oil.  They still think inflation will come back online--just because.  And the economy is chugging along at a fast enough clip to justify a late April rate hike.

After an abrupt jolt 5bps higher in 10yr yields, the day was done and we've been sideways ever since.