Recap 6-19-13: Bernanke to Markets: Surprise!


The FOMC statement itself wasn’t a surprise, but the decrease in the FOMC projection for unemployment by 20bps over the next few years was interpreted hawkishly, even though the number of voters anticipating the first hike occurring in 2015 increased to 15 from 14. Even more importantly, during the press conference Bernanke noted that the FOMC’s forecasts, if accurate, would be consistent with an end to purchases by the middle of 2014, assuming a 7% unemployment rate then. In aggregate, the market is now expecting a tapering at the September meeting. In addition, when asked if bond markets were properly discounting FOMC forecasts, Bernanke did not say no.

The Fed has decreased its Unemployment projections by at the past several meetings, but the decline we saw today was surprisingly large. The most recent forecasts are now inline with a simple linear extrapolation since the Unemployment peak. This suggests that, barring a substantial pickup in growth, continued improvements to the Fed Unemployment forecast is likely to moderate. Nevertheless, the size of the change in forecast is VERY substantial. Model outputs suggests that it COULD be consistent with a ~100bp higher Fed Funds rate for 3 years forward.

This is all a surprise for several reasons. First, the Fed has indicated over the past few months that they are not keen on a repeat of the 1994 bond sell off. With 10y real yields up 77bps in the past 6 weeks, or 670bps on an annualized basis, some market participants may have believed that the Fed would not be comfortable with the pace of the move. Second, recent data has not at all been supportive of an upgrade to the outlook of this magnitude. As a reminder, the ISM print for May was below 50, which signaled that industrial production may be contracting. As a result, it’s probably fair to say that today’s meeting was a fairly major surprise to markets globally. Despite Bernanke’s support for ‘transparency’ in central bank policy making, this particular move from appeared to have come from behind a veil.

In aggregate, Bernanke has signaled a definite bear market in USD rates products. As a result, the carry trades that have been built up for the last several years are all at risk. Assets as diverse as Euribor and Australian Bank Bill futures, which are supposed to reflect domestic economic conditions, moved sharply on this. The red contracts (1 year forward) for example, moved to price in half a hike or so, even though higher US rates are more likely to slow growth! I am not an EM specialist, but I can only imagine how EM rates products will react given significantly worse liquidity conditions.

The general outlook now should probably be for another round of deleveraging that may be worse than what we’ve seen recently. When the smoke clears, there should be plenty of mispriced assets, but the fire may have just gotten started.


  • FOMC projections:
  1. 2014 Unemployment 6.65% vs 6.85% prev
  2. 2015 Unemployment 6.0% vs 6.25% prev
  3. 2014 Core PCE: 1.65% vs 1.85% prev

BOE voted 6-3 to leave QE unchanged. King, Miles and Fisher voted to extend QE by 25bn GBP.

BoC Governor Poloz:

  1. The rotation of demand will require more than just the ramping up of production. The sequence we can anticipate is the following: foreign demand will recover; our exports will strengthen further; confidence will improve; companies will invest to increase capacity; existing companies will expand and new ones will be created.
  2. The Bank expects that the gathering momentum in foreign demand should help lift the confidence of Canada’s exporters. This is critical for Canadian firms to boost their investment to expand their productive capacity.

Upcoming Data:

  • Thu: EU PMI, UK Retail Sales, US Jobless Claims, Markit PMI, Philly Fed, Existing Home Sales,
  • Fri: Canada CPI, Retail Sales,
  • Mon: German IFO, Mexico Unemployment,
  • Tue: US Durable Goods Unemployment, Consumer Confidence, New Home Sales, South Korea Business Survey
  • Wed: Mexico Trade Balance, US Oil Inventories,