Must-know: The Fed reduces asset purchases by another $10 billion

Market Realist

Important takeaways from the January 2014 FOMC meeting (Part 1 of 4)

Ben Bernanke’s parting shot

Yesterday, the Federal Reserve ended its January Federal Open Market Committee meeting and decided to continue to reduce asset purchases. It will reduce purchases of Treasuries by $5 billion a month and purchases of mortgage-backed securities by $5 billion a month, which means the Fed will continue to build its balance sheet by $65 billion a month instead of $85 billion a month. The new level will begin in February. This was Ben Bernanke’s final FOMC meeting as Chairman before the torch passes to the “dream team” of Janet Yellen and Stanley Fischer. 

Market reaction

Bonds initially sold off on the news, with the ten-year trading above 2.72. Then bonds rallied, and the yield dropped to 2.68%. Stocks sold off on the report, with the S&P 500 falling 6 points. Stocks were already weak due to the emerging markets sell-off, so it’s hard to read too much into the Fed reaction. Mortgage-backed securities were flat.

Tapering seems to be on autopilot

After the December FOMC meeting, Steve Liesman of CNBC asked if the Fed plans to reduce asset purchases by something like $10 billion every meeting from now on. Bernanke mentioned all of the caveats about decisions depending on data, but it looks like this will be a constant until the Fed is no longer purchasing assets. The Fed will continue to reinvest maturing proceeds back into asset purchases. Ben Bernanke stressed that the Fed’s balance sheet is still growing, but it just isn’t growing as fast as it was. Bernanke was asked if that meant the Fed would likely still be conducting asset purchases in mid-2014 (as was the previous guidance), and he said QE would probably end in late 2014.

Implications for homebuilders

For homebuilders like Lennar (LEN), KB Home (KBH), Standard Pacific (SPF), PulteGroup (PHM), and Toll Brothers (TOL), this means mortgage rates are going to rise. As mortgage applications continue to fall (today, the Mortgage Bankers Association Mortgage Applications Index is hovering around 2001 levels) the Fed’s footprint in the TBA market got bigger and bigger. It made sense to lower the Fed’s impact on the MBS market.

Rising mortgage rates aren’t helpful for homebuilders, but they’re not the only thing that matters. As the economy improves, homebuilders will get increased traffic as people’s financial situations get better. We recently saw that household net worth increased by something like $1.9 trillion over the past quarter. This will matter much more to the builders than 30 or 40 basis points on the 30-year fixed-rate mortgage.

In the next parts of this Market Realist series, we’ll review the Fed’s current economic forecasts.

Continue to Part 2

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