Amidst all the selling that followed the Federal Reserve's latest statement, an important and positive step may have been overlooked: the Fed's unexpected reentry into the mortgage-backed bond market. "It's a small step, so we're not going to get too excited, but the fact that he even dipped his toe in that water is good news," says David Zervos, head of global fixed income at Jefferies.
Zervos says despite the desire to maintain a treasuries-only portfolio, the Fed is worried that the household sector isn't feeling the stimulus they've put into the economy. "Clearly the message from this statement is that they're worried about the mortgage market, they're worried about the fact that there has not been a large refinance," he says.
While many believe the Fed is out of bullets, Zervos thinks it's a big mistake to rule out the depth their abilities. He thinks investors missed an opportunity to think about the Fed policy as a "transmission mechanism" and the "virtuous cycle" that Ben Bernanke is trying to create.
Here's how he breaks it down: "What we haven't been able to do is get the debt service costs from the level they were 3 0r 4 years ago. We need to reduce those debt service costs, just like we reduced them for corporates and just like we reduced them for banks. That's what monetary policy does. You get people 2oo basis points off their mortgage and they spend some money. If they spend some money, (on movies, potato skins or a vacation) the small businesses see it and they start to hire people. That's the transmission to the jobs markets."
Basically, he believes the Fed has done a poor job addressing the household balance sheet. "This has been a problem for the Fed in terms of the way they want to transmit monetary policy easing. It's all gotten kind of clogged up in the corporates and the banks and the households have been left behind," Zervos explains.
With 70% of GDP tied up in the hands of consumers, it is clear that help for the individual homeowner makes sense. "The mortgage rates (advertised) on the banks front window are low, but people can't seem to access them," he says, adding that "in a sense what the Fed did yesterday was good news for that. They're recognizing it, finally."
So while Zervos believes the Fed still has tools to work with and has turned an important corner by attempting to help the household sector, there are plenty of problems the Fed can't fix like the European banking system and a looming Greek default.
"The single most important thing the Fed can do, ultimately, is try to get the dollar weaker and get a little bit of inflation in the system. They need to get that done," Zervos says.
"I think he (Bernanke) did disappoint people who were looking for QE, but I think he didn't disappoint us on is his ability to think outside the box," says the bond strategist. And contrary to today's price action, Zervos believes today's market reaction has been "too beared up."