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Why does the Fed now see increasing confidence in credit?

Brent Nyitray, CFA, MBA

Important takeaways from the December 2013 FOMC minutes (Part 3 of 8)

(Continued from Part 2)

Review of the financial situation

The Fed noted that over the intermeeting period, the S&P 500 (SPY) increased and bonds rallied, presumably on the back of the decision not to taper at the September meeting. It said the market pushed out its estimate for the first taper. It gets this information from primary dealers through its Desk Survey. Primary dealers trade Treasuries in the primary market, which means they trade directly with the Fed. This is a lucrative business.

The Fed viewed the increase in bond yields as being driven by stronger economic data, and by the market’s assumption that the Fed would probably begin to taper at the December meeeting. The Desk Survey data indicated the market was expecting the first reduction between December and March.

The Fed noted that credit availability generally increased and even went as far as describing leveraged loan issuance as “robust.” While the shutdown did slow down corporate issuance a bit, the market is still very strong and many large firms have taken advantage of the low interest rates to refinance long-term debt at very attractive rates. The Fed watches this like a hawk and is very sensitive to investors “reaching for yield.” “Reaching for yield” is code for being a little too reckless and not taking into account risk. The Fed is understandably gun-shy about this after the financial crisis.

On the household front, it noted that home price appreciation continues—although it did say it believed credit standards remain tight. It doesn’t believe the appreciation we’ve seen since real estate bottomed will be sustainable. Refinance activity had more or less dried up, as mortgage rates increased by 100 basis points since bottoming in May.

So to sum it up, the credit markets are functioning well, aside from the few hiccups we saw related to the government shutdown. Both corporations and households are finding themselves able to access the credit markets. Increased availability of credit is extremely important to commercial REITs like Simon Property Group (SPG), Boston Properties (BXP), Kilroy (KRC), Vornado (VNO), and S.L. Green (SLG).

Continue to Part 4

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