The Economy and Bond Market Radar (July 16, 2012)

Saturday, July 14th, 2012

The Economy and Bond Market Radar (July 16, 2012)

Treasury yields headed lower again this week but not dramatically so. The minutes from the June Federal Open Market Committee meeting were released this week and indicate that Fed members remain divided on an additional round of quantitative easing (QE). In the past few years bonds have tended to rally into the QE announcement and sell off when announced as expectations are for the easing to boost the economy and financial assets. There was little in the way of real market moving economic data released this week in the U.S. but China released second quarter GDP results showing a deceleration to 7.6 percent on a year-over-year basis. This was the slowest growth since the financial crisis but is far from the “hard landing” that many were expecting. Treasury yields moved higher on Friday and the stock market rallied, in what was likely a “relief” rally for stocks.

Strengths

• We did get some inflation data this week with import prices and the producer price index; both continue to show a benign inflation environment.
• Brazil and South Korea cut interest rates this week, following the coordinated actions last week from the ECB, Bank of England and the Bank of China.
• Consumer credit hit a five-month high in May as the consumer appears to be more comfortable and banks are lending.

Weaknesses

• Chinese imports slowed dramatically in June to 6.3 percent, well below estimates. This raises concerns about the depth of the slowdown in China.
• Japanese core machinery orders plummeted 14.8 percent in May, dramatically below estimates.
• Quarterly earnings reports will pick up sharply next week but we had many companies warn this week that the economy is weakening. This was particularly true in technology and industrials.

Opportunity

• The Fed reaffirmed its commitment to an ultra low interest rate policy through 2014 and additional monetary easing is possible in the near future.

Threat

• Europe remains a wildcard with the markets shifting focus on a weekly basis.

Tags: Bank Of China, Bank Of England, Bond Market, Chinese Imports, Deceleration, Ecb Bank, Economic Data, Federal Open Market Committee, Financial Assets, Import Prices, Inflation Data, Interest Rate Policy, Japanese Core, Machinery Orders, Market Radar, Open Market Committee, Producer Price Index, Quarter Gdp, Quarterly Earnings Reports, Treasury Yields
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Out-of-Sync Markets Create Long-Term Opportunities

Monday, July 9th, 2012

Principal and Portfolio Manager Francis “Frank” Gannon provides thoughts regarding the economy, the markets and small-cap investing. Frank, a former panelist on Louis Rukeyser’s Wall Street, has 19 years of investment management experience and joined our team in 2006.

“I know what is around the corner—I just don’t know where the corner is…”*

- Kevin Keegan, Former International Footballer and former manager of the England National Football Team

Sentiment once again shifted dramatically in the second quarter of 2012, just as it did in 2011 and 2010. Now-familiar concerns over contagion from the ongoing sovereign debt crisis/fiscal crisis/recession across Europe, coupled with fears of decelerating growth in China and a fragile economic recovery in the United States, pressured the equity markets.

Even the Federal Open Market Committee (FOMC), at its most recent meeting in June, added to the air of uncertainty, as they lowered their expectations for economic growth and raised the forecast for the unemployment rate. At the same time, lack of clarity regarding fiscal policy and the coming “fiscal cliff” in January 2013 is building, further weighing on domestic economic activity and the markets.

After gaining more than 12% in the first quarter of 2012, the Russell 2000 Index lost 3.47% in the second quarter and was up 8.53% year-to-date through June 30, 2012. Interestingly, the small-cap Russell 2000 Index will soon mark the five-year anniversary of its pre-financial crisis peak, July 13, 2007. From this peak through the end of 2012′s second quarter, the Russell 2000 gained 0.04%.

To be sure, it has been an eventful five years for equities, the global economy, and geopolitics. We live in a world that craves certainty, yet the range of possible outcomes in today’s world feels infinite. To that concern, we are often asked how in today’s uncertain environment we marry the various top-down macro views and our bottom-up stock picking approach.

In today’s interconnected world, where random, unpredictable events across the globe are being priced into the markets at lightning speed, one’s ability to react is paramount to achieving consistent, long-term results. Our discipline of responding rationally without making predictions is built for just this type of environment.

Predicting what will be the next macro drivers of the markets has long been a favorite pastime for many strategists, fund managers, and market commentators alike. It is not ours. Our expertise is in smaller-company investing. We typically have little if anything to say about the economy in general and even less to say about large-scale, macro trends.

That being said, we are in the business of responding rationally to opportunities as they are created and being prepared to do so when they occur. In today’s interconnected world, where random, unpredictable events across the globe are being priced into the markets at lightning speed, one’s ability to react is paramount to achieving consistent, long-term results. Our discipline of responding rationally without making predictions is built for just this type of environment.

We once again find ourselves in another out of sync moment, where those same daily macro headlines are creating long-term micro opportunities. Not surprisingly, since the Russell 2000′s most recent peak in March the most defensive areas of the market have performed best while those more economically sensitive areas have dramatically underperformed. It is the same performance pattern we have witnessed during the market’s corrective phases over the last two years.

From our perspective, however, those defensive areas of the market (consumer staples, utilities, and REITs) remain expensive. At the same time, many of the economically sensitive areas of the market that have been hit the hardest are fraught with opportunity. Ironically, lost among the economic headlines and fear of owning these cyclical businesses are the quality standards we tend to focus on. For the moment, economic sensitivity is trumping quality, a byproduct of our macro-driven world.

Stay tuned…
FDG

*A favorite quotation of mine from a presentation courtesy of Dylan Grice, global strategist for Societé Generale, entitled “Macro & the Margin of Safety” that was delivered to the Value Intelligence Conference 2012, summing up the futility of macro investing.

Important Disclosure Information
Francis Gannon is a Portfolio Manager of Royce & Associates LLC. Mr. Gannon’s thoughts in this essay concerning the stock market are solely his own and, of course, there can be no assurance with regard to future market movements. No assurance can be given that the past performance trends as outlined above, will continue in the future. The Russell 2000 is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 index.

Tags: Contagion, Debt Crisis, England National Football Team, Federal Open Market Committee, Fiscal Crisis, Fiscal Policy, Fomc, Footballer, Frank Gannon, Global Economy, Kevin Keegan, Louis Rukeyser, Macro Views, national football team, Open Market Committee, Portfolio Manager, Russell 2000 Index, Small Cap, Sovereign Debt, Term Opportunities, Unemployment Rate
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Gold Market Radar (June 11, 2012)

Sunday, June 10th, 2012

Gold Market Radar (June 11, 2012)

For the week, spot gold closed at $1,593.45 down $30.65 per ounce, or 1.89 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, beat bullion with a slight loss of 0.59 percent. The U.S. Trade-Weighted Dollar Index fell 0.54 percent for the week.

Strengths

• The U.S. Mint reported that sales of American Eagle gold bullion coins in May rose 158 percent over the total number purchased in April. Sales of American Eagle silver bullion coins rose 89 percent in the same period. However, sales in May 2012 were down from levels attained in May 2011 for both gold and silver bullion coins. On a positive note, recent SEC filings showed George Soros has been buying gold again.
• While the gold stocks were the star performers in the prior week, silver stocks on average turned in positive gains despite a flat silver price. Lately mining stocks have been outperforming the bullion prices.
• Gold maintained its recent gains most of the week until Fed Chairman Ben Bernanke spoke before Congress on Thursday and did not affirm that the Fed was compelled to immediately start QE3, particularly in response to recent weak job numbers. Short-term traders immediately started shorting gold. Speculative interests have declined significantly over the past year with the Comex speculative open interest recently at 13.6 million ounces net long, down from 28 million ounces, so there is plenty of room for this number to grow, once the Fed or Congress is forced to scream “Uncle!”

Weaknesses

• From recent Fed statements, some of the Federal Open Market Committee (FOMC) members appear to have warmed up to another round of QE, as some economic data has been downright disturbing as of late. When Bernanke refrained from outlining steps that the central bank may take to bolster the economy amid risk from Europe’s debt crisis, gold futures tumbled the most in two months. Instead the Fed indicated it is going to assess more data before acting.
• Barrick Gold’s Board of Directors announced this week that it had replaced Aaron Regent, President and Chief Executive Officer, with Chief Financial Officer Jamie Sokalky. Barrick’s vision is to be the world’s best gold company by finding, acquiring, developing and producing quality reserves in a safe, profitable, and socially responsible manner. Analysts worry that the company may lower guidance.
• A Court of Appeals ruling orders the U.S. Forest Service to consult with wildlife agencies prior to granting Notices of Intent to weekend hobbyists using suction dredges to mine for gold in the Coho Salmon critical habitat in northern California. This could be bad news for all U.S. small miners and explorations working on Forest Service lands with critical wildlife habitat. This decision sets a major precedent across the western states and may render the Forest Service impotent to meaningfully address low impact mining without deferring to other agencies such as the EPA.

Opportunities

• Morgan Stanley conducted a survey of 2,019 urban and rural gold buyers across 16 Indian cities and eight Indian states. The survey report notes that Indians own 20,000 tons of gold worth $1 trillion. Respondents from several households said they expect gold prices to rise by 8 percent in 2012. The survey notes that gold is not the first asset that Indian households liquidate during bad times; it is equities. Gold remains an important asset class for investment, having outperformed most other asset classes over the past five years.
• In a recent address to the Committee for Monetary Research and Education, Bob Hoye noted policymakers are now getting margin calls on their massive experiment in government intrusion and it is likely coming to an end. In studying history, Bob sees a pattern in which the state spends, borrows, inflates and raises taxes until all of the wealth is consumed. Consequent hardship becomes widespread and forces folks to tighten their belts, who in turn, force local and federal governments to tighten theirs. Policymakers have an economic interest in maintaining the bubble but ultimately running the money printing presses cannot keep a mania going.
• Bob points out that typically in the year a bubble maxed out, gold’s real price set a significant low and then increased for some twenty years thereafter. If Congress does not reach agreement on several important tax and budget policy issues before the end of this year, the impending fiscal cliff could be a big hit to GDP growth and could be sufficient enough to push the economy into recession in 2013.

Threats

• Bernanke’s remarks pointed that action is required by Congress to set the right policies to lead the country forward. Congress cannot wait to see if a third quantitative easing sets the ship right. It seems the major central bankers have agreed to a common script, pointing to the failings of fiscal policymakers (i.e., politicians). Mario Draghi of the ECB commented, “Some of these problems in the Euro area have nothing to do with monetary policy. That is what we have to be aware of and I do not think it would be right for monetary policy to compensate for other institutions’ lack of action.” Central bankers are trying to put pressure on their political leaders to address the root causes of the crisis which are beyond the scope of monetary policy.
• With this being an election year, we may be at an impasse with little room to compromise where brinkmanship and stand your ground may be more important than doing the right thing. Gold prices have been highly sensitive to what monetary policymakers have done for much of the past year and with low visibility towards a resolution, it could be a trader’s market for the next couple of quarters with the potential for some large price moves if the stresses become acute.
• If the Fed wants to do something, it really has to be June 19-20 because the window will start to close once the election campaign moves into high gear.

Tags: American Eagle Gold, American Eagle Gold Bullion Coins, April Sales, Ben Bernanke, Bullion Prices, Federal Open Market Committee, George Soros, Gold Bullion Coins, Gold Futures, Gold Market, Gold Miners, gold stocks, India, Market Radar, Nyse Arca, Open Market Committee, Silver Bullion Coins, Silver Price, Silver Stocks, Spot Gold, U S Mint
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The Economy and Bond Market (May 21, 2012)

Saturday, May 19th, 2012

The Economy and Bond Market (May 21, 2012)

Treasuries rallied this week, sending long-term yields sharply lower. With headlines touting bank runs in Greece and Spain, the risk-off trade was in full swing this week as both gold and the U.S. dollar rallied along with Treasuries. Ten-year Treasury yields hit the lowest level in 60 years this week and German 10-year bonds hit new record lows as part of the risk-off/fear trade.

Strengths

• The consumer price index for April was unchanged and the trend in inflation data is lower.
• Housing starts rose 2.6 percent in April as the housing market remains a bright spot.
• Central banks remain supportive as the Fed minutes released from the April Federal Open Market Committee (FOMC) meeting hinted at more monetary easing if the economy slows. The Bank of England echoed similar thoughts and the market sees higher chances of additional quantitative easing.

Weaknesses

• The Conference Board Leading Economic Index fell 0.1 percent in April.
• Chinese power production rose a modest 0.7 percent, the smallest gain since May 2009.
• Eurozone industrial production fell 0.3 percent in April; expectations were for a gain of 0.4 percent.

Opportunity

• Bonds continue to grind higher and appear to be forecasting benign inflation and slow growth.
• The Federal Reserve appears willing to increase monetary accommodation if necessary, which would be a boost to the bond market.

Threat

• China’s economy is slowing faster than expected and government policy makers appear comfortable with this dynamic.
• Europe remains a wildcard with austerity programs under pressure, creating significant uncertainty.

Tags: 10 Year Treasury, Austerity Programs, Bank Of England, Bond Market, Central Banks, Chinese Power, Consumer Price Index, Economic Index, Eurozone, Federal Open Market Committee, Full Swing, Government Policy Makers, Housing Market, Housing Starts, Inflation Data, Open Market Committee, Record Lows, Term Yields, Treasuries, Treasury Yields
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Explaining the Stir over Recent “Fed-Speak” (American Century)

Friday, March 23rd, 2012

Explaining the Stir over Recent “Fed-Speak”

by Robert Gahagan, Senior Vice President, Senior Portfolio Manager, American Century Investments
and John Eichel Investment Writer

March 20, 2012

The official statement from the Federal Reserve’s March 13 interest rate policy committee meeting was relatively ho-hum (no significant changes from January’s statement), but other recent Fed communications have raised more of a stir. In particular, we explain what “fiscal cliff” and “sterilized QE” mean, and help put them into context. It’s all part of a mixed, uncertain economic outlook in which slower mid-year growth, like last year, can’t be ruled out, but higher inflation by next year is also a possibility.

The U.S. Federal Reserve (“the Fed”—the U.S. central bank) announced no immediate significant changes or tweaks in U.S. monetary policy after its latest Fed Open Market Committee (FOMC) meeting on March 13. The Committee voted to keep the federal funds rate target for short-term interest rates at a historically low 0–0.25% (where it’s been since December 2008), continuing, as it did in January, to say that it “anticipates that economic conditions…are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”

The Committee also voted to continue “Operation Twist”-related selling of short-term U.S. Treasury securities and purchases of long-term Treasury securities. This strategy is intended to rebalance and refocus the Fed’s balance sheet toward longer maturities, designed to help keep long-term interest rates (such as home mortgage rates) low (see “Our Take on the Fed’s 50-Year Anniversary Revival of ‘Operation Twist,’” American Century Investments Blog, posted September 26, 2011).

Swirling Speculation about Inflation Risks

But the lack of change in the Fed’s last policy statement doesn’t mean that all is quiet and calm at the central bank. Despite the mostly status-quo nature of the statement, speculation has been swirling in the background among economists and other market participants and observers (and, reportedly within the Fed itself) regarding the Fed’s next policy moves or announcements.

Much of the speculation has centered on the accuracy of the Fed’s economic assessments and projections, especially its ability to accurately assess inflation risks. Up to this point, the Fed’s front-line position has left no doubt that the majority of its key current policy-makers remain much more concerned about the sustainability of the post-Great Recession economic recovery than about inflation, as demonstrated by the Fed’s continued extremely accommodative monetary strategies.

Uncertainties about the Actual Strength of the U.S. Economy

But some Fed critics (and governors within the Fed) think that the economic recovery is significantly stronger and more sustainable than the Fed is stating. They argue that the Fed is risking higher inflation and the formation of new speculative asset bubbles (like subprime mortgages and housing, before the Great Recession, or the Tech Bubble in the late 1990s) by continuing such a sustained period of unprecedented monetary accommodation.

One of the trillion-dollar questions of 2012-13 is whether the Fed will further stimulate the recovering U.S. economy (with more measures beyond the low federal funds rate target), or if it will have to scale back the accommodation to address the potentially inflation-fueling/bubble-building momentum of nearly five-straight years of unprecedented accommodative policy moves (dating back to 2007). Or, will it somehow have to both stimulate growth and contain inflation?

Busy Weeks for Fed Communications

Some of the speculation has been fueled by the Fed itself, from its recent statements and speeches, and also from selective releases of information via the central bank’s unofficial (but widely acknowledged) mouthpiece at the Wall Street Journal (WSJ), veteran Fed beat writer Jon Hilsenrath.

The two weeks just prior to the latest FOMC meeting—the weeks beginning February 27 and March 5—were particularly intriguing from a recent Fed communications standpoint. On February 29 and March 1, Fed Chairman Ben Bernanke gave his semiannual monetary policy report to the Congress (what used to be called Humphrey-Hawkins testimony), appearing before the House Financial Services Committee on February 29, and before the Senate Banking, Housing, and Urban Affairs Committee on March 1.

The Approaching “Fiscal Cliff”

Among the biggest attention-grabbers from those legislatively mandated Bernanke appearances was a fiscal-policy warning to Congress, outlining what could happen early next year if Congress continues to waffle and stall on budgetary matters.

Bernanke doesn’t typically highlight fiscal policy (government spending and programs to aid the economy), in his remarks, but in this case he pointedly warned that the U.S. economy faces a potential “massive fiscal cliff” on January 1, 2013 if President George W. Bush-era tax cuts, President Obama’s payroll tax cut, and extended unemployment benefits are all allowed to expire at that time, and $1.2 trillion in automatic mandatory across-the-board spending cuts agreed to last August are allowed to kick in.

As reported by the WSJ and the Congressional newspaper, The Hill, Bernanke warned: “Under current law, on January 1, 2013, there’s going to be a massive fiscal cliff of large spending cuts and tax increases. I hope that Congress will look at that and figure out ways to achieve the same long-run fiscal improvement without having it all happen at one date.”

An Argument to Remain Accommodative

Bernanke warned that allowing tax cuts to expire and trimming fiscal spending could slow economic growth. “You … have to protect the recovery in the near term,” he said. The idea that the recovery might be threatened by the fiscal cliff helped put downward pressure on U.S. stock indices on February 29, according to financial media reports that day.

Because of its potential economic impact, the possible fiscal cliff has been cited by some analysts in defense of the Fed’s continued accommodative policies, adding it to the list of significant headwinds facing the economy this year, which include the weak housing market, high unemployment, tight consumer credit conditions, high gas prices, and unsettled conditions in Europe and the Middle East.

Considering QE3

With short-term U.S. interest rates effectively at 0% for over three years, the Fed hasn’t had much maneuvering room in terms of making monetary policy more accommodative. One alternative that the Fed has pursued pretty aggressively over that period has been quantitative easing (QE—buying U.S. government securities to increase liquidity in the financial system and to keep long-term interest rates low).

We have already seen two recent waves of Fed QE in the U.S. (QE1, from 2008-2010, and QE2, from 2010-11) and a third is being considered, depending on the direction of economic data in 2012. (There’s a favorite saying of economists and analysts that “the decision to execute QE is data-dependent.”)

The primary data that QE depends on are economic growth signals and short-term interest rates—if the economy appears to be in recession or sliding in that direction, and short-term interest rates are too low to cut further, QE may be (and has been) called for.

The Case for “Sterilized QE”

But one of the risks of QE is inflation—adding liquidity and keeping interest rates low can eventually create demand pressures that can push up prices. It can also devalue the dollar relative to other currencies, which is also inflationary. As we mentioned earlier, the Fed now finds itself in a position where it’s still considering another round of QE (QE3) because of economic uncertainties, but it doesn’t want to trigger more potential inflation pressures.

The result: so-called “sterilized QE”—a form of QE described by Hilsenrath in the WSJ on March 7 (in what many speculated was a Fed-planted article) as follows: “The Fed would print new money to buy long-term mortgage or Treasury bonds but effectively tie up that money by borrowing it back for short periods at low rates…employing new market tools they have designed to better manage cash sloshing around in the financial system. Transactions like those… are called ‘reverse repos.’ A related program called ‘term deposits’ also ties up short-term money held by banks.”

Later in the article, Hilsenrath also provided this clarification: “The Fed hasn’t literally printed more money, but it has electronically credited the accounts of banks and investors with new money when it purchased their bonds under quantitative easing.”

Basically, “sterilized QE” is QE with more liquidity controls. We can elaborate on its details in future updates if it looks like it will actually be implemented—we should get more clues from the April and June FOMC meetings. For now, the Fed appears to be just letting us know what options it is considering.

Another interesting thing about this Hilsenrath article was its timing—it appeared the day after the U.S. stock market’s worst performance day of the year (when the S&P 500 dropped over 1.5%, and was down 2.2% over a two-day period), raising speculation that it was timed to help boost the market and confidence (which it apparently did—the S&P 500 rallied 3.9% over the next five sessions). This, along with the “fiscal cliff” example, show how closely tuned the markets are to what the Fed is saying and how they’re tracking what its intentions are.

The Continued Case for Inflation Protection

What’s the lesson for investors from all of this? We suggest being prepared for several different economic and market scenarios in 2012. In other words, stay diversified. If the Fed—with all of its research tools and economic brainpower at its disposal—is uncertain about the economic outlook, we all should tread lightly.

As the President and Chief Executive Officer of American Century Investments, Jonathan Thomas, has been writing to fund shareholders in our shareholder reports this year: “More market volatility appears likely in 2012…as uncertainties regarding European debt, economic strength, government budget deficits, and the U.S. presidential election sway investors. We believe strongly in adhering to a disciplined, diversified, long-term investment approach during volatile periods.”

We also believe in striving for inflation protection. Both the Fed and its critics appear to be giving serious consideration to the longer-term inflation implications of the past nearly five-straight years of accommodative monetary policies, and we suggest investors should too. To serve investors’ needs, American Century Investments offers a suite of funds that aim to provide various forms of inflation protection, utilizing holdings that include commodity and precious metal-linked securities, foreign securities and currencies, and inflation-linked bonds.

American Century Investments^® offers a wide variety of stock, bond and asset allocation funds. Visit americancentury.com for more information: Individual Investors | U.S Investment Professionals

Download a PDF of this post.

The opinions expressed are those of Robert V. Gahagan and the fixed income portfolio management team at American Century Investments, and are no guarantee of the future performance of any American Century Investments portfolio. This information is not intended to serve as investment advice; it is for educational purposes only.

Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.

Diversification does not assure a profit, nor does it protect against loss of principal.

Copyright © American Century Investments

Tags: American Century, American Century Investments, Economic Outlook, Federal Funds Rate, Gahagan, Home Mortgage Rates, Inflation Risks, Interest Rate Policy, Investment Writer, Maturities, Open Market Committee, Policy Committee, Portfolio Manager, Qe, Rate Target, S Central, Senior Vice President, Term Interest, Treasury Securities, U S Treasury
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No QE3 – Yippee!

Thursday, March 15th, 2012

No QE3 … Yippee!

March 13, 2012

by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.

Key Points

• The Fed made no major changes to its policy statement and announced a continuation of Operation Twist, but did not hint at or announce further quantitative easing.
• The Fed’s assessment of the economy did improve somewhat.
• Richmond Fed President Lacker’s dissent and Dallas Fed President Fisher’s pronouncements ring true.

In the policy statement released at the conclusion of its latest meeting, the Federal Reserve upgraded its assessment of the economy, noting improvement in labor conditions, and did not suggest imminent additional monetary easing, while keeping the fed funds rate in the 0-0.25% range it’s been in since the end of 2008. Key in the statement released by the Federal Open Market Committee (FOMC): “Labor market conditions have improved further; the unemployment rate has declined notably in recent months but remains elevated.”

Lacker dissents … again

There was one dissenter, Richmond Fed Bank President Jeffrey Lacker, who did so for the second consecutive time and who “does not anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate through late 2014.”

As for financial conditions, “strains in global financial markets have eased, though they continue to pose significant downside risks to the economic outlook.” The Fed made no change to what’s become the key sentence in its statements, noting that conditions would probably warrant “exceptionally low” short-term interest rates at least through 2014.

The Fed also subtly upgraded its assessment of the investment environment. Business investment spending is said to have “continued to advance,” whereas in its January 25 statement the FOMC said it “has slowed.”

Addressing energy prices

There wasn’t much new in the Fed’s statement other than addressing the short-term inflationary implications of the recent spike in energy prices. Inflation “has been subdued in recent months although prices of crude oil and gasoline have increased lately.” The increase in oil prices “will push up inflation temporarily, but the committee anticipates that subsequently inflation will run at or below the rate that it judges most consistent with its dual mandate.”

Operation Twist continues, but no QE3

“The Committee also decided to continue its program to extend the average maturity of its holdings of securities as announced in September.” In other words, “Operation Twist” is ongoing, but there was no mention of extending it beyond its scheduled June expiration. That will likely be discussed and detailed at the next FOMC meeting in late April.

For those who’d been expecting a third round of quantitative easing (QE3)—and we were not among them—the reasoning is likely already noted above: the economy has not only picked up its pace of growth, but the unemployment rate has also begun to ease meaningfully. Remember, both price stability (inflation) and resource utilization (maximum employment) are the Fed’s mandates. With recent conflicting data on both, and the rarity of the Fed changing course amid conflicting signals, QE3 was unlikely in our opinion.

Personally, I disagree with the many who feel the only prop under this very strong market has been quantitative easing. I do believe the economy has entered the second phase of the recovery (the expansion phase) in which jobs will be more plentiful, small businesses will be greater participants, and even housing will be a positive contributor. The market’s recent strength—and importantly, its surge immediately after the Fed’s announcement into today’s close—supports this view.

Fisher speaks the truth

The subject of QE3 was likely discussed and debated, but we’ll have to wait until the minutes of the meeting are released in three weeks to get any details. I share the view of Richard Fisher, President of the Dallas Fed, who’s publicly said that economic conditions are improving and the underlying trend of inflation is “converging on the Fed’s 2% target.” Key to Fisher’s perspective is that the liquidity injected into the financial system via QE1 and QE2 hasn’t traveled into the real economy, but instead sits on banks’ balance sheets, invested in financial assets, parked in cash—or even parked at the Fed itself.

Why keep treating a recovering patient like it remains in the operating room? Fisher recently said, somewhat bluntly, that he sees “no need to administer additional doses unless the patient goes into postoperative decline.” He went on to suggest that if incoming data continues to show accelerating improvement in the economy, “the markets should begin preparing themselves for the good Dr. Fed to wean them from their dependency rather than administer further dosage.” Hear, hear.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Tags: Bank President, Charles Schwab, Chief Investment Strategist, Consecutive Time, Dallas Fed, Dissents, Downside Risks, Fed Funds Rate, Fed President, Federal Funds Rate, Federal Open Market Committee, Global Financial Markets, Investment Environment, Jeffrey Lacker, Key Sentence, Liz Ann, Open Market Committee, Richmond Fed, Senior Vice President, Unemployment Rate
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The Transparent Fed

Tuesday, February 7th, 2012

The Transparent Fed

February 2, 2012

by Rob Williams
Director of Income Planning, Schwab Center for Financial Research

and Kathy A. Jones
Vice President, Fixed Income Strategist, Schwab Center for Financial Research

Last week, the Fed unveiled a new communications strategy. They provided forecasts for growth, inflation and interest rates for the next several years. The negative bias in the rate forecasts surprised bond markets. They point to the likelihood, given current information, that the Fed will keep short-term interest rates at zero until the end of 2014 due to expectations of slow growth and subdued inflation. One view on these forecasts is that it’s too difficult to forecast so far into the future and that the Fed might be wrong and be forced to reverse course. Another view (ours, for the record) is that increased transparency is good, a positive in an open market.

• The Fed’s move is consistent with the trend toward openness. From appearances on “60 Minutes” to press conferences after the meetings of the Federal Open Market Committee (FOMC), Chairman Bernanke has transitioned the Fed from opaqueness under Alan Greenspan to more transparency. These steps bring the U.S. in line with other central banks that have provided long-term rate forecasts, such as Sweden and the U.K. By providing more information, the argument goes, the Fed can help businesses and individuals plan more clearly for the long-run and dampen market volatility. The transparency of forecasts gives them a tool to change their views more flexibly and reduce the number of “surprise” policy changes.
• The Fed also announced an explicit 2% inflation target for the first time in its history. This explicit inflation target also helps reduce uncertainty about policy long-term. The Fed will use the 2% annual target, based on changes in personal consumption expenditures (PCE) as their measure. The current year-over-year increase in PCE is 1.8% in the latest numbers. So they’re still a touch below those targets. Bernanke was asked in the press conference following the meetings, “why PCE and not the consumer price index?”  One reason is that in CPI, housing has a far greater weight.  It appears to have understated inflation during the housing bubble and may overstate it now that renting is more popular than buying. The PCE is also adjusted more flexibly to changing consumption patterns. Fed critics might also argue that annual increases in PCE also tend to be lower than changes in the CPI.

Multiple Measures of Inflation Still Below Target

Note: The Consumer Price Index (CPI) measures changes in the price level of consumer goods and services purchased by households. The CPI in the United States is defined by the Bureau of Labor Statistics as “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.”  Core inflation (Core CPI) is a measure of inflation which excludes certain items that face volatile price movements, notably food and energy. The preferred measure by the Federal Reserve of core inflation in the United States is the Core Personal Consumption Expenditures Price Index (PCE), which is put out by the Bureau of Economic Analysis of the Department of Commerce.

Source: Bloomberg, using monthly data as of December 2011.

• Notably, the Fed did not announce a policy target for the second part of their dual mandate—employment. They explained this by saying that a host of other factors, including productivity, demographics and public policy, might change the level of maximum employment over time. Today unemployment is 8.5%, undeniably above the level of structural unemployment considered optimal now. The improving trend in unemployment may seem inconsistent with the Fed’s indication that policy will remain “extremely accommodative”—meaning, they’ll use every tool possible to keep rates low. But they do have a long-run estimate (not a target) for full employment at a rate closer to 5.5%. We think this leaves the door open to more quantitative easing in the second or third quarters of this year.
• The Fed’s growth forecasts were below consensus expectations. In the past, the Fed has released economic projections based on individual forecasts from the 5 Fed Governors including Bernanke and 12 Federal Reserve District Bank presidents. They present the central tendency, or average, of 17 participants. Despite a run of good economic data over the last few months, the central tendency (i.e. average) of the forecasts lowered the estimate for 2012 GDP growth to a range of 2.2% to 2.7% from the previous estimate of 2.5% to 2.9%. They also lowered their expectations for 2013 to between 2.8% and 3.2%, from 3.0% and 3.5% in November, and increased them slightly for 2014.
• Transparency should decrease uncertainty over what the Fed is watching and why. One side of the debate says to “keep it to yourselves.” We don’t want to know, in particular that your range of forecasts varies so widely. Another perspective is that it allows us to see what the Fed is watching most closely. And they can change their policy and consensus more flexibly. A critical point that the projections make clear: There is no single projection, and there are different views that can change over time on the committee depending on the data. We believe that the voting members of the Fed will gladly change their positions, if economic conditions (in their view) warrant it.

Earn Your Coupon

Corporate bonds have surged out of the gates in the first month of the year, benefiting from the post-holiday rush of confidence in U.S. equity markets, stronger appetite for risk and Fed statements that they’ll keep their policies accommodative. In fact, the riskier sectors of the corporate market, including much-maligned U.S. bank debt, have outperformed their “safe-sector” government counterparts. What’s our view of the prospects from here?

• We continue to see investment-grade corporate bonds as a place to look for yield. We’ve been one voice advocating this, and maintain that view. The overall fundamentals, in our view, such as reduced corporate leverage, improved profit margins and declining financial market volatility are positives. You can see thoughts from Kathy Jones on bank bonds in the “A Second Look at Bank Bonds” article in November. However, given the magnitude of the rally in recent weeks and ongoing risks emanating from Europe, we suggest near-term caution.
• Long-term, we expect 2012 to be the year of “earning the coupon” as compared to 2011, when much of the return in bonds came from price appreciation. Even with the extremely accommodative policy stance by the Fed, we believe that the potential for further price appreciation in bonds is limited. We’d suggest adding new positions during the pockets of time where pricing is more attractive.
• Higher risk sectors, such as financials, have rebounded the most. U.S. banks in particular have benefited from the relative calm injected into the European banking sector by the European Central Bank’s (ECB’s) move to increase liquidity in the financial system through their recently launched Long Term Refinancing Operation (LTRO). This program provides very low-cost loans to European banks, with very permissive guidelines on the collateral required to back those loans, for up to three years. This has lessened the pressure on European banks and helped increase demand for yield in U.S. bank bonds.
• Higher risk sectors are still vulnerable to negative shocks. Even with increased liquidity in the European banking system and improved U.S. investor sentiment, more aggressive, higher yielding sectors are still the most vulnerable to negative surprises from the European debt crisis and domestic economy. With growth in the developed world still fragile, in our view, bank and finance bonds are likely to remain the most volatile. We think utilities, consumer staples and other less cyclical sectors are likely to be relatively more stable.

Prices Rise for Corporate and Bank Bonds

Source: Bloomberg, using monthly data as of December 2011.

State Revenue Watch

The Rockefeller Institute of Government publishes widely referenced quarterly reports on state revenue trends, including their latest this week. In Q3 2011 and preliminary Q4 2011, state tax revenues increased significantly “while the overall economy has been growing at a relatively slow pace.” The revenue trend is encouraging. But “such a disparity” between revenue collections and the real economy “is not sustainable over time,” in their view. This may be just fine, in our view, assuming state legislatures stay on the broad course of budget discipline. In contrast, the full impact of the Great Recession on local government tax revenue—2/3 of which, on average, come from property taxes—for many issuers will continue to lag.

• State revenues grew for the seventh consecutive quarter. Total tax revenues were up 6.1%, according to the Rockefeller data, in Q3 2011 from the prior year. However, the decline starting in late 2008 was severe, so there’s been a lot of ground to make up. Nationwide, collections are still 5.3% lower than three years ago in real terms (i.e. adjusted for inflation.) The pace of revenue recovery has been dramatic, off the extreme lows of Q3 2009. But the pace has slowed, leveling out below prior peaks as expenditures rise.
• Local government revenues have faired less well. Local governments rely more heavily on property taxes, which account for more than 2/3 of total revenue for local governments, compared to the heavier reliance on sales and income taxes for state governments. As we’ve mentioned in previous updates, the impact on property taxes, particularly after a crisis so heavily driven by real estate, is generally slower. Nationwide, real (inflation-adjusted) tax revenues for local governments fell 2.0% over the last four quarters ending in Q3 2011, compared to 0.2% growth from Q3 2009 to Q3 2010, according to the Rockefeller report.
• Austerity and tight budget management remain the themes for now. While state revenue trends are strengthening, a parallel report from the Center on Budget and Policy Priorities points to continued expenditure pressures, focusing on U.S. States. Twenty-nine states project budget gaps in 2013, and health care, education and entitlement costs are ongoing challenges. The expiration of 2009 Recovery Act stimulus spending adds to these pressures. State and local governments are required by statute or their constitutions to deliver balanced budgets. But that doesn’t make cuts any less painful, politically. For the most part, however, states are making adjustments to keep budgets balanced.
• Multiple-notch downgrades. The notion of multiple-notch downgrades for some municipal issuers has gained modest media attention lately. As we wrote in the January 20th edition, rating downgrades outpaced upgrades in the last half of 2011. Moody’s also reported late last year that the number of “multi-notch” downgrades has also increased, though they remain a relatively small proportion of the number of rating actions. Often the cause is issuer-specific, related to lack of pro-active budget cuts leading to a sharp decline in financial reserves and cash balances. We expect that we’ll see more of these downgrades, especially for smaller, local governments and issuers who haven’t acted as aggressively to raise revenues or cuts costs. This is an issue for investors who hold these bonds, of course, but not, in our view, the broader market. We continue to believe that diversification by issuer or professional management using funds or managed accounts can help investors with these challenges.
• Current valuation. Investors have been clamoring for new muni bonds in the first part of the year. Supply of new issue munis has remained tight, however, pushing yields down to a touch above historic lows. The ratio of municipal to treasury yields has also fallen to under 100% for AAA-rated maturities under 10 years. Generally, we still like munis for core portfolio positions for the combination of credit quality and tax-exempt yield. But in the same vein as the comments about corporates above, we’d also suggest adding positions during pockets of weakness for buy-and-hold investors with favorable long-term views. Consider looking for yield in the middle of the curve or in credits a step down (but not too far down) the ladder from AAA, such as the high end of the “A” range in credit, minimum, or higher quality issuers with maturities from 7-15 years in laddered portfolios.

Muni Prices Peaking

Source: Barclays Capital, daily data as of January 30, 2012.

What About CDs?

Many savers are being forced to accept the painful reality that returns on cash in checking and savings accounts may remain quite low for some time. Some investors had grown accustomed to alternatives such as Certificates of Deposit (CDs) for slightly higher yields. Like other fixed income investments, the CD market has grown in complexity. Finding the right CD investment can be challenging. We think it’s worth highlighting the major questions we hear with thoughts on how to help investors through this market.

• What drives CD rates? Primarily, short-term rates and changing supply in the CD market. CD rates, like other fixed income products, will often depend on how many banks are in need of capital and what they’re willing to pay compared to the alternatives. In other words, more competition for the same assets could mean higher rates offered to investors, and vice versa. Moreover, interest rates on CDs and other cash investments are driven by the yields on short-term Treasuries and the Fed Funds rate. Treasury yields are low and effectively zero in short-term maturities. So are the rates offered on CDs with shorter maturities.
• We don’t expect that rates on CDs will move much higher in 2012, given the Fed’s low rate policies. Fed Chairman Bernanke has noted whenever asked that the Fed acknowledges the difficulties for savers. His response: the Fed’s mandate is employment and inflation. If those remain consistent with economic strength, then savers, in their view, will benefit. This isn’t particularly encouraging. But it’s the reality short-term savers may continue to face for some time.
• What are brokered CDs? CDs are bank products, not investments. That is, they’re the obligation of a bank, similar to cash. But methods of distribution of individual CDs may vary. “Bank” CDs are usually sold directly to a customer from a local branch. “Brokered” CDs are sold in the “brokered” market with wider distribution.
• One primary difference between bank and brokered CDs… is how a CD buyer might sell them in the event they wanted their money back before maturity. Although not required by law, most bank CDs can be redeemed early, usually after paying an early redemption fee. There are no formal guidelines governing the penalty amounts. Brokered CDs are generally traded on the secondary market. While there is generally no early-redemption fee, the price a seller might receive is dependent on the price a buyer is willing to pay.
• What about CDs from foreign banks? Some foreign banks with US branches offer CDs to U.S. savers. For all practical purposes, there isn’t much difference compared to a CD from a U.S. bank. The key feature, we believe, is FDIC protection. If a foreign bank fails, the FDIC promises to make the investor whole, up to coverage limits. In our view, foreign bank CDs with this feature can be compared on equal terms (all other terms being equal) to CDs offered by domestic banks with FDIC coverage.
• Other features may matter as much as yield. For most investors, yield and maturity are generally the most important issues. How much will you be repaid, and when? Other features, such as calls, a variable interest rate or estate features may also be valuable. Given the wide range of possibilities, purchasers, in our view, should look carefully at the other characteristics, if they want them, and how they may serve their needs.
• What role should CDs play in the cash investment and fixed income portion of an investor’s portfolio? Unfortunately, CDs and other cash investments have recently been less effective income producers in most investors’ portfolios than they have been historically. Yields are low and may not rise soon. Purchasers may be able to find slightly higher yields in CDs with longer maturities. Like a bond, the investor commits to the lower rate should rates rise, potentially with lower liquidity. Also keep in mind that CDs can be subject to interest rate risk and even issuer credit risk if you’re already over the FDIC protection limits. But for some, CDs with an above average rate may help support the more secure portions a fixed income portfolio. For more insight, see SCFR’s “What about Cash” and “Choosing CDs and Other Cash Investments” articles at schwab.com/marketinsight under Investing > Cash.

Please visit www.schwab.com/onbonds for more fixed income perspective from the Schwab Center for Financial Research. If you have questions or concerns about the issues raised in this publication, please speak to your Schwab representative.

Important Disclosures

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Income from municipal bonds may be subject to the Alternative Minimum Tax (AMT), and capital appreciation from discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.This report is for informational purposes only and is not an offer, solicitation or recommendation that any particular investor should purchase or sell any particular security or pursue a particular investment strategy. The types of securities mentioned herein may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation.All expressions of opinion are subject to change without notice in reaction to shifting market conditions. We believe the information obtained from third-party sources to be reliable, but neither Schwab nor its affiliates guarantee its accuracy, timeliness, or completeness.International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.Past performance is no guarantee of future results.Diversification strategies do not assure a profit and do not protect against losses in declining markets.Funds deposited at an FDIC insured institution are insured, in aggregate, up to $250,000 per depositor, per insured institution based upon account type by the Federal Deposit Insurance Corporation (FDIC). The FDIC considers any other deposits you may have with an issuing bank. CDs you purchase from a particular bank are aggregated with any other deposits you may have with the issuing bank for determining FDIC insurance coverage (e.g., if you already have deposits of $250,000 with a bank, don’t purchase CDs from the same bank in the same ownership category).Barclays Capital Municipal Bond Index consists of a broad selection of investment-grade general obligation and revenue bonds of maturities ranging from one to 30 years. It’s an unmanaged index representative of the tax-exempt bond market.Barclays Capital U.S. Corporate High-Yield Bond Index covers the USD-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P isBarclays Capital U.S. Corporate Bond Index covers the USD-denominated, investment grade, fixed-rate, taxable corporate and non-corporate bond markets. Securities are included if rated investment-grade (Baa3/BBB-/BBB-) or higher using the middle rating of Moody’s, S&P, and Fitch.Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly.The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

Tags: Alan Greenspan, Bernanke, Bond Markets, Central Banks, Communications Strategy, Current Information, February 2, Federal Open Market Committee, Fixed Income, Fomc, Inflation Target, Market Volatility, Negative Bias, New Communications, Opaqueness, Open Market Committee, Personal Consumption Expenditures, Schwab, Strategist, Term Interest
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Journey to the Center of the (Fed’s) Mind (Sonders)

Friday, January 27th, 2012

Liz Ann Sonders
Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.

January 25, 2012

Key Points

• The Federal Reserve opted to keep short-term interest rates on the floor and extended the period of time during which rates are likely to remain near zero.
• Newly published forecasts show slightly better growth, a bit less inflation and a lower unemployment rate.
• Fed Chairman Ben Bernanke got hit with a lot of questions about the risks of extending zero-rate policy for 2 ½ more years.

First, the statement

The Federal Reserve was more explicit in its statement today, which accompanied the finale of the Federal Open Market Committee’s (FOMC) two-day meeting today.

“…the Committee decided today to keep the target range for the federal funds rate at 0 to ¼ percent and currently anticipates 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.”

The reference to 2014 was an extension of the Fed’s previous pledge to keep rates low at least until mid-2013. Although several Fed officials have said even further easing (read: quantitative easing round three, or QE3) is needed to revive hiring and housing, there was one notable dissent today: “Voting against the action was Jeffrey M. Lacker [Richmond Federal Reserve Bank President], who preferred to omit the description of the time period over which economic conditions are likely to warrant exceptionally low levels of the federal funds rate.”

The Fed did say it would continue its “Operation Twist” program, which has been extending the average maturity of its $2.6 trillion securities portfolio.

Frankly, I have reservations about the two-and-a-half year span during which the Fed expects to keep short rates effectively pegged at zero. Much can and will likely happen between now and then, be it economic conditions and/or inflation trends. Given that the Fed has often been criticized in the past for being behind the curve, it almost guarantees it will do it again by this effective promise. And, it can also be seen as yet another hit to savers and retirees.

As noted by High Frequency Economics, “they are now too cautious, expecting only ‘modest’ growth as far as the eye can see. We see no mention of the sustained surge in bank business lending, the rebound in survey data, the upturn in every housing indicator and only a tangential reference to the plunge in the pace of layoffs. The markets face two dangers if these emerging trends persist. First, the Fed might have to renege on its ‘promise’—the word ‘likely,’ after all, is not a solemn vow—or, second, they might tighten by reversing QE, while sticking to zero rates. Either way, fingers get burned in the markets.”

Second, the forecasts

Shortly after the release of the FOMC statement, the Committee released expectations of the five Fed board members and 12 district bank presidents. Of these 17 Fed officials, nine expect short-term interest rates to remain below 1% by the end of 2014, while six expect rates to remain at zero into 2015. The Fed also lowered its estimates for growth and inflation this year, a move consistent with its statement as noted above.

These projections are new for the Fed—it’s the first time in FOMC history that it’s explicitly laying out its forecast for growth, inflation and rates. Assuming an increase in rates sometime in late 2013 or 2014, it would be the first rate hike since June 2006. Think about that: as noted below, there are two Committee members that think the first hike should come in 2016—if that’s the case, it would mean a full decade of no rate hikes.

There was no unanimity with regard to the pace at which the Fed should raise rates:

• Three officials believe they should begin rising this year.
• Another three believe they should begin moving higher next year.
• Five say they should go up in 2014.
• Four say 2015.
• And two even believe the first hike shouldn’t come until 2016!

By the way, the Fed

It’s estimated that US economic growth, as measured by real gross domestic product, will be between 2.2% and 2.7% (from the fourth quarter of 2011 through the fourth quarter of this year). For 2013, US growth is forecasted to be between 2.8% and 3.2%. (The forecasts are calculated using a “central tendency forecast,” which excludes the three lowest and highest projections.)

As for inflation, it’s projected to drop below the Fed’s newly stated goal of 2%, with the majority of officials expecting inflation in a range between 1.4% and 2.0% through 2014. These are marginally lower inflation projections than those published last November.

And, in keeping with the recent traction seen in job growth, the Fed’s forecasts for the unemployment rate have also ticked down and now sit at between 8.2% and 8.5% for 2012, 7.4% and 8.1% for 2013 and 6.7% and 7.6% for 2015. These forecasts are below the prior forecasts published last November.

(For a more detailed look at the Fed officials’ economic projections, see the full chart in today’s Fed release.)

Third, the press conference

My friend Steve Liesman, from CNBC, asked the first question, and it was a good one. He essentially wanted to know whether the Fed was doubting the economic improvement that’s been seen in the past few months. Bernanke did acknowledge improvement in some areas, but “mixed results” in others; specifically: “We continue to see headwinds emanating from Europe, coming from the slowing global economy.” He also said, “I don’t think we’re ready to declare that we’ve entered a new, stronger phase at this point. We’ll continue to look at the data.”

There were additional questions that got to this subject. One asked whether there was risk of a backlash from the Fed’s new information, particularly by hurting confidence by suggesting the economy is weaker than people think. Bernanke’s response: “Those considerations are outweighed by the need to maintain accommodative conditions,” so it’s attractive for companies to invest and hire, and for people to buy houses.

Bernanke did address the fact that the individual forecasts don’t have names attached to them. He indicated that they aren’t disclosing the identities for a reason—to ensure discussion at meetings and to depersonalize monetary policy.

Bernanke did not escape politics in the questioning, and was asked about the hostility toward the Fed during many of the Republican debates. In particular, he attempted to fight back against the criticism that Fed policy is crushing savers and retirees: “The savers in our economy are dependent on a healthy economy in order to get adequate returns.”

Finally, the Chairman was asked about his confidence in the Fed’s forecasting abilities. At least he was honest when he replied, “Our ability to forecast three and four years out is obviously very limited. Nevertheless we have to make a best guess, a provisional plan,” much like companies do. “It’s certainly possible we will be either too optimistic or too pessimistic,” which suggests the Fed may have to adjust to the realities of the actual data.

We think that’s a real possibility.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Tags: Bank President, Ben Bernanke, Charles Schwab, Chief Investment Strategist, Fed Chairman, Fed Officials, Federal Funds Rate, Federal Open Market Committee, Federal Reserve Bank, Journey To The Center, Lacker, Liz Ann, Open Market Committee, Qe3, Resource Utilization, Senior Vice President, Target Range, Twist Program, Unemployment Rate, Zero Rate Policy
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Fed Ends 2011 with a Whimper (Sonders)

Wednesday, December 14th, 2011

December 13, 2011

Liz Ann Sonders
Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.

Key Points

• There were no surprises out of the Fed meeting today, with short-term interest rates remaining pegged at zero.
• There was one dissenting FOMC member who wished for additional policy accommodation.
• Much of the Fed’s near-term focus remains on the eurozone debt crisis.

The Federal Open Market Committee (FOMC) held its final meeting of 2011 and went out with a bit of a whimper. There were very few changes in its statement relative to November’s, although it did mildly upgrade its assessment of the economy: “The economy has been expanding moderately, notwithstanding some apparent slowing in global growth.” The Fed also gave a nod to recent improvement in jobs: “While indicators point to some improvement in overall labor market conditions, the unemployment rate remains elevated.”

However, the Fed did downgrade its assessment of the investment climate: “Household spending has continued to advance, but business fixed investment appears to be increasing less rapidly and the housing sector remains depressed.” This last comment about housing was a touch perplexing given what it didn’t contain: any nod to the fact that in the past month there have been strong readings for mortgage applications, easier mortgage lending conditions and a surge in homebuilder sentiment.

There was one dissenter—Chicago Fed Bank President Charles Evans—who wanted further easing. This was his second consecutive dissent, supporting “additional policy accommodation,” according to the statement. “There’s simply too much at stake for us to be excessively complacent while the economy is in such dire shape,” Evans said in a speech last week in Indiana.

No QE3, but Operation Twist affirmed

Surprising to us has been the fact that there’s been some chatter about the Fed considering a third round of quantitative easing (QE3). We’ve felt since the Fed’s announcement of “Operation Twist” in September, it was unlikely to follow up so soon with QE3. The Fed has basically said the risks were too high and it was disinclined to expand its balance sheet any further.

The Fed did note it would continue its exchange of $400 billion of short-term debt with longer-term securities to lengthen the average maturity of its holdings, the move referred to as Operation Twist, which doesn’t expand the Fed’s balance sheet. And of course, the economy has improved markedly since September, with the unemployment rate down to 8.6%.

Across the pond

But the US economy isn’t all that’s on the minds of Fed policymakers. They’ve sounded increased warnings about the eurozone debt crisis, and in today’s statement noted: “Strains in global financial markets continue to pose significant downside risks to the economy outlook.” On November 30, the Fed led six global central banks and announced a 0.5% cut in the cost of emergency dollar funding for banks, with the money coming from the Fed’s currency swap lines. Over the subsequent week, the European Central Bank’s three-month dollar lending through the swap lines jumped to nearly $51 billion, up from $400 billion before the announcement.

New communications strategy coming?

There’d been some pre-meeting speculation that the Fed would begin to outline a new communications strategy, having noted in the minutes following the Fed’s November 2 meeting that “such accommodation would likely be more effective if it were provided in the context of a future communications initiative.” We didn’t get any details out of today’s meeting, and that may be a function of its one-day length, versus the longer two-day meetings during which meatier topics are typically discussed. We’ll be looking for more detail about that in late January (2012′s first FOMC meeting takes place January 24 and 25), if not before then.

What would be the purpose of a revamped communications strategy? Fed Chairman Ben Bernanke has consistently stressed, “…for central banks with policy rates near the zero lower bound, influencing the public’s expectations about future policy actions became a critical tool.” In other words, when rates are already pegged at zero, one of the few tools left is words. More to come on that as we approach the Fed’s next meeting.

Important Disclosures
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Tags: Bank President, Charles Evans, Charles Schwab, Chicago Fed, Chief Investment Strategist, Debt Crisis, Fed Meeting, Federal Open Market Committee, Household Spending, Indicators Point, Investment Climate, Liz Ann, Mortgage Applications, Mortgage Lending, Open Market Committee, President Charles, Qe3, Senior Vice President, Term Focus, Unemployment Rate
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Fed Ends 2011 with a Whimper (Sonders)

Wednesday, December 14th, 2011

Fed Ends 2011 with a Whimper

December 13, 2011

by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.

Key Points

• There were no surprises out of the Fed meeting today, with short-term interest rates remaining pegged at zero.
• There was one dissenting FOMC member who wished for additional policy accommodation.
• Much of the Fed’s near-term focus remains on the eurozone debt crisis.

The Federal Open Market Committee (FOMC) held its final meeting of 2011 and went out with a bit of a whimper. There were very few changes in its statement relative to November’s, although it did mildly upgrade its assessment of the economy: “The economy has been expanding moderately, notwithstanding some apparent slowing in global growth.” The Fed also gave a nod to recent improvement in jobs: “While indicators point to some improvement in overall labor market conditions, the unemployment rate remains elevated.”

However, the Fed did downgrade its assessment of the investment climate: “Household spending has continued to advance, but business fixed investment appears to be increasing less rapidly and the housing sector remains depressed.” This last comment about housing was a touch perplexing given what it didn’t contain: any nod to the fact that in the past month there have been strong readings for mortgage applications, easier mortgage lending conditions and a surge in homebuilder sentiment.

There was one dissenter—Chicago Fed Bank President Charles Evans—who wanted further easing. This was his second consecutive dissent, supporting “additional policy accommodation,” according to the statement. “There’s simply too much at stake for us to be excessively complacent while the economy is in such dire shape,” Evans said in a speech last week in Indiana.

No QE3, but Operation Twist affirmed

Surprising to us has been the fact that there’s been some chatter about the Fed considering a third round of quantitative easing (QE3). We’ve felt since the Fed’s announcement of “Operation Twist” in September, it was unlikely to follow up so soon with QE3. The Fed has basically said the risks were too high and it was disinclined to expand its balance sheet any further.

The Fed did note it would continue its exchange of $400 billion of short-term debt with longer-term securities to lengthen the average maturity of its holdings, the move referred to as Operation Twist, which doesn’t expand the Fed’s balance sheet. And of course, the economy has improved markedly since September, with the unemployment rate down to 8.6%.

Across the pond

But the US economy isn’t all that’s on the minds of Fed policymakers. They’ve sounded increased warnings about the eurozone debt crisis, and in today’s statement noted: “Strains in global financial markets continue to pose significant downside risks to the economy outlook.” On November 30, the Fed led six global central banks and announced a 0.5% cut in the cost of emergency dollar funding for banks, with the money coming from the Fed’s currency swap lines. Over the subsequent week, the European Central Bank’s three-month dollar lending through the swap lines jumped to nearly $51 billion, up from $400 billion before the announcement.

New communications strategy coming?

There’d been some pre-meeting speculation that the Fed would begin to outline a new communications strategy, having noted in the minutes following the Fed’s November 2 meeting that “such accommodation would likely be more effective if it were provided in the context of a future communications initiative.” We didn’t get any details out of today’s meeting, and that may be a function of its one-day length, versus the longer two-day meetings during which meatier topics are typically discussed. We’ll be looking for more detail about that in late January (2012′s first FOMC meeting takes place January 24 and 25), if not before then.

What would be the purpose of a revamped communications strategy? Fed Chairman Ben Bernanke has consistently stressed, “…for central banks with policy rates near the zero lower bound, influencing the public’s expectations about future policy actions became a critical tool.” In other words, when rates are already pegged at zero, one of the few tools left is words. More to come on that as we approach the Fed’s next meeting.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Tags: Bank President, Charles Evans, Charles Schwab, Chicago Fed, Chief Investment Strategist, Debt Crisis, Fed Meeting, Federal Open Market Committee, Household Spending, Indicators Point, Investment Climate, Liz Ann, Mortgage Applications, Mortgage Lending, Open Market Committee, President Charles, Qe3, Senior Vice President, Term Focus, Unemployment Rate, Whimper
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