Why stocks and bonds are rallying on a Goldilocks FOMC statement

Market Realist

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

A much more benign reaction to the June FOMC statement

Yesterday, the Federal Reserve ended its June Federal Open Market Committee meeting and decided to continue to reduce asset purchases. It will reduce its purchases of Treasuries by $5 billion a month. It will also reduce its purchases of mortgage-backed securities by $5 billion, which means the Fed will continue to build its balance sheet by $35 billion a month instead of $45 billion a month. The new level will begin in July.

Market reaction

Bonds rallied off on the news, with the ten-year closing at 2.58. Stocks rallied off on the report, with the S&P 500 adding 14 points. The market seemed to be focusing on the forecast for GDP, which was taken way down, given the weakness in Q1. That said, the Fed remains sanguine about inflation, which makes this more or less a “Goldilocks” type of statement.

The consensus is forming that the first rate hike will be in 4Q 2015

The attached scatter chart shows where the individual FOMC members see the Fed funds rate at different periods. If you compare the last chart (after the March FOMC meeting), you’ll see no change in the consensus from March. In her press conference, Yellen acknowledged the jump in the Consumer Price Index but said that it’s “noisy” and reiterated that the Fed will be data-dependent with respect to the Fed funds rate.

Implications for homebuilders

For homebuilders like Lennar (LEN), D.R. Horton (DHI), PulteGroup (PHM), and Toll Brothers (TOL), this means mortgage rates are eventually going to rise. Today, the Mortgage Bankers Association Mortgage Applications Index is hovering around 2001 levels. As mortgage applications continue to fall, the Fed’s footprint in the TBA market gets bigger and bigger. It made sense to lower the Fed’s impact on the MBS (mortgage-backed securities) 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 $2.9 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. Investors who are interested in investing in the entire homebuilding sector should look at the S&P SPDR Homebuilder ETF (XHB).

Continue to Part 2

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