Fed Taper Announcement Pulls the Dow Jones Today Down

The Dow Jones Industrial Average (DJINDICES: ^DJI  ) and S&P 500 (SNPINDEX: ^GSPC  ) both dropped immediately after the Federal Reserve announced another $10 billion reduction to its monthly asset purchase program, finishing the day down 114 points to 16,222 and 11 points to 1,860, respectively. Every monthly Federal Open Market Committee concludes with a statement on the panel's thinking regarding the economy and the actions the Fed plans to take on interest rates and asset purchases. The market always eagerly awaits these statements, as interest rates play a dominant role in determining the value of all other assets.

Starting in April, the Fed will only purchase $55 billion per month in long-term assets -- $25 billion worth of mortgage-backed securities and $30 billion in long-term Treasury bonds.

The Fed also again changed the wording in the statement regarding when it will consider raising interest rates from the current near-zero interest rate policy. Below, I dissect today's statement and compare it to January's release. The emphasis is mine and indicates a change from the previous statement. One Fed member voted against the March statement, particularly calling out the fifth paragraph as weakening the sixth. Paragraphs 5 and 6 are denoted by *5* and *6*, respectively.

Jan 28-29 2014

March 18-19 2014

Information received since the Federal Open Market Committee met in December indicates that growth in economic activity picked up in recent quarters.

Information received since the Federal Open Market Committee met in January indicates that growth in economic activity slowed during the winter months, in part reflecting adverse weather conditions.

Labor market indicators were mixed but on balance showed further improvement. The unemployment rate declined but remains elevated.

Labor market indicators were mixed but on balance showed further improvement. The unemployment rate, however, remains elevated.

Household spending and business fixed investment advanced more quickly in recent months, while the recovery in the housing sector slowed somewhat.

Household spending and business fixed investment continued to advance, while the recovery in the housing sector remained slow.

Fiscal policy is restraining economic growth, although the extent of restraint is diminishing.

Fiscal policy is restraining economic growth, although the extent of restraint is diminishing

Inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable.

Inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.

The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate.

The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate.

The Committee sees the risks to the outlook for the economy and the labor market as having become more nearly balanced.

The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced.

The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.

The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.

Taking into account the extent of federal fiscal retrenchment since the inception of its current asset purchase program, the Committee continues to see the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy.

The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions.

In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to make a further measured reduction in the pace of its asset purchases.

In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases.

Beginning in February, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $30 billion per month rather than $35 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $35 billion per month rather than $40 billion per month.

Beginning in April, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $25 billion per month rather than $30 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $30 billion per month rather than $35 billion per month.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.

The Committee's sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate.

The Committee's sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee's dual mandate.

The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.

The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.

If incoming information broadly supports the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.

If incoming information broadly supports the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.

However, asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.

However, asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.

*5* To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate.

The Committee also reaffirmed its expectation that the current exceptionally low target range for the federal funds rate of 0 to 1/4 percent will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

 

In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.

In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.

The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal.

The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.

*6* When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.

 

The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

 

With the unemployment rate nearing 6-1/2 percent, the Committee has updated its forward guidance. The change in the Committee's guidance does not indicate any change in the Committee's policy intentions as set forth in its recent statements.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Richard W. Fisher; Narayana Kocherlakota; Sandra Pianalto; Charles I. Plosser; Jerome H. Powell; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Richard W. Fisher; Sandra Pianalto; Charles I. Plosser; Jerome H. Powell; Jeremy C. Stein; and Daniel K. Tarullo.

 

Voting against the action was Narayana Kocherlakota, who supported the sixth paragraph, but believed the fifth paragraph weakens the credibility of the Committee's commitment to return inflation to the 2 percent target from below and fosters policy uncertainty that hinders economic activity.

While the Federal Reserve is again lowering its monthly asset purchases, now down from the maximum of $85 billion per month, it still has a massive $4.2 trillion balance sheet; including the reinvestment of coupons, the Fed is adding to it by nearly $70 billion a month.

Banks, the prime beneficiaries of the low federal funds rate, immediately jumped on the news that the near-zero interest rate policy will remain "for a considerable time after the asset purchase program ends." JPMorgan Chase (NYSE: JPM  )  was at one point up 0.5% to $58.35, Bank of America (NYSE: BAC  ) rose 1.25% to $17.41, and Citigroup (NYSE: C  ) jumped 1.5% to $48.87.

BAC Chart

BAC data by YCharts.

Banks make money by taking in deposits at low interest rates and loaning out that money to businesses for higher interest rates, earning the spread between the two. The banks sank back down when Fed Chairwoman Janet Yellen clarified in the post-meeting press conference that by "considerable time" the committee meant "something on the order of six months, or that type of thing." The market was surprised by the Fed's definition of "considerable time"; nowadays even the Fed has a short time horizon.

Banks will remain the prime beneficiaries, and savers the main losers, as the Fed keeps short-term interest rates low. The central bank is trying to boost the housing market and push up asset prices by forcing savers to invest their money in risky assets. This has proven successful in boosting the stock market to the point at which it is expensive, and in keeping long term mortgage rates low, but has been less successful in boosting the economy.

Foolish takeaway
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