The FOMC completed their July meeting today with little fanfare. Their official statement alluded to ‘modest’ economic growth as of late (downgraded from ‘moderate’), reflecting recent weaker figures, as well as an acknowledgement of improved but continued struggles with high unemployment, as well as federal budget tightening and weak overseas growth. For now, the QE bond buying program will continue, with no hints given as to its end (it may have been assumed enough damage was done between meetings in regards to policy clarity to encourage even more carefully controlled language than usual).
While ‘taper talk’ spooked markets in recent months, the reality of this is that tapering will happen—although the timeframe is still up for debate. Some economists think it could be as soon as September, others assume December-January or even beyond. It’s not possible to tell yet, and decisions will be dependent on economic data coming out over the next several months. Despite some strength this spring, summer data has fallen off a bit. Of course, the stronger the data, the more likely and more quickly tapering will occur; the weaker the data, the farther the timeframe may get pushed out a few meetings further.
Underlying this are interest rate expectations, which have leveled off from highs, but remain under upward pressure. Rates in the short term are notoriously difficult to anticipate, but over the long run, tend to have a loose correlation with nominal GDP growth. So, now, roughly 1.7% inflation + 1.7% real GDP growth gets us to 3.0-3.5% on the 10-year Treasury in a ‘fair value’ sense, assuming some room for error in either direction. Expect more information from us regarding management of fixed income positions in this type of environment, in an ongoing evolution to an even more ‘defensive’ posture with long-term expectations for rising rates.
Lastly, we are likely to see much more press and discussion regarding the potential successor to Ben Bernanke as Chairman. While early yet (and early predictions tend to be largely irrelevant, per past experience in reviewing these chairmanships), it appears current Vice Chair Janet Yellen and former White House economic advisor and Treasury Secretary Larry Summers are the leading candidates. Yellen’s views appear largely in keeping with the current administration, so may provide a higher level of consistency in terms of soothing market fears. Summers, on the other hand, is a controversial character and considered to be a bit of a ‘hothead’ by some, and has also been more vocal about of the potential downsides of qualitative easing in recent years. So, an appointment in this direction could make markets a bit nervous. But much more to come.