Well, I’m surprised that the FOMC decided to dial back its securities purchases by $10B per month. I’m further surprised that US stock markets rallied on this news. I did not expect them to change course. Market analysts are taking that as a vote of confidence in the economy’s health. It’s too bad they rely on rigged statistics to gauge the economy’s health; they should read Shadow Government Statistics instead. The more significant news is that the Fed is leaving the target federal funds rate at zero. That ensures that banks will still be able to borrow at almost no cost and hold Treasuries, maintaining their risk-free carry trade. Perhaps the bond-buying program isn’t as crucial to the economy as ZIRP. It’s still worth $75B each month and it’s not ending all at once.
I wonder whether the inventory of agency MBS available from GSEs was a factor in the Fed’s decision. This May 2013 research paper from the Federal Reserve Bank of New York finds that the MBS market has plenty of liquidity. The housing market’s recovery (which in turn is driven by ZIRP making mortgages cheap) also means MBS look more attractive to institutions. If that’s really the case, the Fed won’t have to work as hard to support MBS valuations. Lots of banks and pension funds own MBSs, so the taper means the Fed seems less worried now about supporting bank balance sheets and keeping pension funds solvent. The Mortgage News Daily MBS Dashboard shows that MBS prices fell slightly across the board today and Treasury yields rose slightly. Less Fed demand for agency paper means the prices fall. These price moves are a more relevant measure of the FOMC’s taper decision.