The FOMC statement out this afternoon went more or less as everyone expected it would. There was not much change in the Fed's rhetoric save for recognition of the fact that the economic data has been coming in better than expected in recent months (although economic surprise indices are now rolling over as well). As Vincent Reinhart -- who believes the chances of QE3 by June are still 75% [12] -- noted after Ben Bernanke's recent visit to Capitol Hill, "stronger incoming data have been mostly ignored by the Fed." While there were slight modifications to the verbiage, the Fed's outlook on monetary policy was identical. A red-line comparison of the last FOMC statement with the one released today was posted earlier on ZeroHedge [13].
SocGen's take (all emphases theirs):
Pointing out that the housing market remains depressed and viewing unemployment as elevated, while at the same time rationalising away the imminent risk of inflation, the Fed leaves the door wide open for a QE3 announcement in April. But the immediate market reaction to the FOMC was muted, suggesting that the market has expected nothing less from the Fed. The Fed does not appear to be in the position to take any option off the table at this critical juncture of the economic recovery. Earlier in the day, retail sales figures surprised on the upside, pushing stocks higher. And yet, the US economy needs to be nurtured by the Fed to gain traction. The Fed is now expected by most market participants to err on the side of being too accommodative. Fix the economy now, worry about inflation later!
This confirms in our view that QE3 is coming.
As Jefferies recently pointed out [14], financial repression schemes have become a common tool in modern sovereign finance over the last century or so, and the FOMC's reiteration today that "economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014" is no exception.
SocGen questions the central bank's grasp on the whole interest rate situation:
10-year swap spreads are already trading below 7bp, down from 15bp at the beginning of the year and around 20bp six months ago. The risk now becomes that QE3 is already widely priced in (announcement effect), after which the actual announcement and its execution could actually lead to higher interest rates.
Where there are winners, there are losers. And one of the main losers of a Fed keeping the economy on life support for as long as possible is the (30-year) Treasury Long-bond. Following the Fed’s announcement, it dropped by almost one point. While the Fed may be able to keep a lid on inflation for three, five or even ten years, the prospect of inflationary pressure creeping up within the next 30 years cannot be ruled out. This is not a good set-up for Wednesday’s 30-year Treasury reopening! Caveat emptor!