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Markets aren’t thrilled with Fed reminder that monetary stimulus isn’t forever

posted on January 3, 2013 at 5:53 pm
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It’s not that the financial markets don’t know that one day the Federal Reserve will take away the liquidity punch bowl called Quantitative Easing 1,2, and 3.

It’s just that the financial markets don’t like to be reminded that the party does have to come to an end.

And that’s just what today’s release of the minutes of the December 11-12 meeting of the Federal Reserve’s Open Market Committee did. The Standard & Poor’s 500 Stock Index, which had been up by as much as 0.2% today fell starting around 2 p.m. New York time to close down 0.21%.

The problem, as far as markets were concerned, is that the minutes revealed a Fed very much divided about how long the current bond-buying program of $85 billion a month ($45 billion in Treasuries and $40 billion in mortgage-backed securities) should run.  Some members of the Open Market Committee thought this program of quantitative easing should continue until the end of 2013. Others thought that there was a need to continue this program but didn’t give a specific time frame for the Fed’s purchases or rule out continuing the program at a lower level of bond buying. A few members said that given the growth in the Fed’s balance sheet it would be appropriate to slow or stop purchases before the end of 2013. (And, as was known before the release of the minutes, one member voted against any additional purchases.)

The immediate response by traders was to dump the longest-dated Treasuries. The 30-year bond continued its recent downward path in price (and therefore it’s upward trajectory in yield) to close at a yield of 3.125%. That’s up from a yield of 2.86762% on December 28.

Bonds were likely to move lower and yields higher anyway on worry about the negotiations over raising the debt ceiling. Credit rating companies such as Moody’s have already noted that the recently completed fiscal cliff deal did nothing to deal with the long-term deterioration of the financial position of the U.S. government. And bond traders know that the last debt ceiling battle produced a cut in the U.S. credit rating to AA from AAA.

Today’s release of the Fed’s minutes with its reminder that the Fed isn’t guaranteed to keep putting cash into the financial markets until the end of 2013 didn’t settle any already jangled nerves.

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