Wednesday, June 14, 2017

Fed Raises Rates, Sets Out Asset Disposal Plan

As was widely anticipated, the FOMC of the Federal Reserve voted 8-1 to raise the federal funds overnight lending rate 25 basis points, from 0.75-1.00% to 100-1.25%. Minneapolis Fed President Neel Kashkari was the lone member to vote to leave the rate unchanged. The Fed also raised the prime rate - to which many credit cards, car and mortgage loans are indexed - by 1/4%. The prime - or Primary, in fed-speak - rate now stands at 1.75%.

While the move was telegraphed to the market well in advance, the Fed's decision to release some details of its plan to unwind its enormous balance sheet of over $4.5 trillion, came as something of a shock to investors, characterized by the sullen market reaction.

About the only assets that didn't go down following the Fed's release were Dow and the dollar, the DJIA saved by the usual antics of the altos or the PPT, with the traditional hockey stick save in the last half hour, which also lifted the S&P, the Comp., and NASDAQ from deeper losses.

The dollar index rallied from 96.36 - a seven-month low - earlier in the day, to close at 96.918, a closing loss of just 0.06%. As usual, precious metals were sold down the river in the heavily-rigged futures market. WTI crude oil closed in New York at 44.69, -1.77 (-3.81%). The price is a massive surprise, considering the "summer driving season" has begun. However, the glut of crude on world markets continues to depress prices. Consumers have not yet seen the result at the gas pump, where prices have been relatively stable, despite oil's recent fall from about $52 to the mid-40s.

As usual, the day following the Fed rate decision will offer more clarity on stock direction.

The Fed laid out plans to wind down its multi-trillion-dollar balance sheet, gradually reducing its holdings of Treasuries and agency securities, by decreasing the Fed’s reinvestment of principal payments. Payments will only be reinvested when they exceed preset and self-administered caps, which start out at $6 billion per month for Treasuries and $4 billion per month for agency and mortgage-backed securities.

Since the Fed sopped up literally trillions worth of garbage MBS and dodgy treasuries during the aftermath of the GFC, the effect of their balance sheet unwind will be an attempt to allow market normalization with the Fed out of the way. While this tactic has been the subject of great scrutiny, without a "buyer of last resort" such as the Federal Reserve, the concern is that interest rates will spiral out of control with inadequate buying interest depressing prices and thus, raising yields beyond reasonable levels.

At present, this has not occurred, In fact, the benchmark 10-year note was exceptionally depressed, closing at a yield of 2.138, but, the Fed hasn't actually begun its unwinding, only mentioned how they plan to achieve their goals.

In an addendum to its statement, the Fed stated,
“The Committee currently anticipates reducing the quantity of supply of reserve balances, over time, to a level appreciably below that seen in recent years but larger than before the financial crisis; the level will reflect the banking system’s demand for reserve balances.”
As the ultimate arbiter of rates and ostensibly in control of all things financial, the Fed is hopeful that the rest of the world will go along with their grand plan.

According to the caps the Fed has just announced, it's going to be a long time before their balance sheet regains some semblance of normalcy. At a rate of $10 billion a month, the Fed will only be able to reduce the bloat by $120 billion a year. At that rate, getting their carried balance down to $2.5 billion would take roughly 20 years.

We can hardly wait.

At the Close, 6/14/17:
Dow: 21,374.56, +46.09 (0.22%)
NASDAQ: 6,194.89, -25.48 (-0.41%)
S&P 500: 2,437.92, -2.43 (-0.10%)
NYSE Composite: 11,779.81, -16.98 (-0.14%)
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