UBS: The Fed Is Going To Regret What Happened Yesterday

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REUTERS/Kim Kyung-Hoon

U.S. Federal Reserve Chairman Ben Bernanke is seen prior to the International Monetary and Financial Committee at the annual meetings of the IMF and the World Bank Group in Tokyo, October 13, 2012.

UBS economist Drew Matus says the Federal Reserve may regret passing up on a rare opportunity to reduce quantitative easing without unduly disrupting the market.

Yesterday, the FOMC (the Federal Reserve's monetary policymaking body) decided to go against market expectations and refrain from announcing a reduction in the pace of monthly bond purchases it makes under quantitative easing.

The market reaction showed that a "tapering" of QE was largely priced in – stocks, bonds, and gold all soared while the dollar tanked.

And because the taper was already largely priced in – such that perhaps markets wouldn't have sold off so strongly on the actual announcement of a taper – UBS economist Drew Matus writes in a note that "the  FOMC may come to regret  passing on this opportunity."

"We would note that opportunities such as the one offered to the Fed today are rare: to date no central bank that has ever begun quantitative easing has been able to exit from those policies," says Matus.

In the note, he writes (emphasis added):

A consequence of this inaction may be that the market will view future Fed communications with some scepticism. We have argued repeatedly that introducing some uncertainty into the Fed’s decision-making process could actually support the Fed’s goals. However, we viewed increasing the uncertainty with regard to the process, not to the goals themselves.

The Fed’s actions today reduce both the transparency the Fed has argued supports their goals AND the clarity of their goals, the latter being more significant as it could cause an unwelcome increase in volatility. This is likely to prove costly when the Fed finally does move to taper.

The bottom line, according to Matus: " In our view, particularly now that any Fed warnings regarding a  taper are likely to be discounted by market participants, there are higher odds of a  disruptive sell-off in equity markets in response to a taper announcement."



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