Taper 2: Fed announces $10 billion taper – USD advances

The FOMC announced a second taper of another $10 billion as expected, with $5 billion coming down from treasuries and $5 billion from MBS. Despite the weak Non-Farm Payrolls, the US economy seems to be on track, continuing its slow and steady recovery. The rout in emerging markets was not expected to move the members of the FOMC. This is Ben Bernanke’s last rate decision, as he steps down on January 31st and hands the baton to Janet Yellen. Changes in the statement, especially the forward guidance and the state of the economy  are closely watched by the markets, and they are marginally more positive.

The US dollar was somewhat lower towards the announcement, with EUR/USD trading around 1.3670, GBP/USD around 1.6580 and USD/JPY just above 102. After the release, the USD is slightly stronger.

Statement

The forward guidance is quite unchanged. The outlook for the economy is slightly better with the job market now seen as “showed further improvement”, rather than mixed. The economy has picked up in recent quarters, according to the announcement.

Forward guidance was adjusted in December. The Fed still says that “current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent”.

Here is the first paragraphs from the announcement:

growth in economic activity picked up in recent quarters. Labor market indicators were mixed but on balance showed further improvement. The unemployment rate declined but remains elevated. Household spending and business fixed investment advanced more quickly in recent months, while the recovery in the housing sector slowed somewhat. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable

For the first time in a long time, the Fed voted unanimously on the move: no dovish dissenters nor hawkish ones.

Market reaction

• EUR/USD dropped from 1.3670 to 1.3640,. Another big tests awaits the pair: see how to trade the US GDP release with EURUSD.
• GBP/USD is sliding down from 1.6580 to 1.6550.
• USD/JPY is quite stable at 102.08.
• AUD/USD is down 30 pips from 0.8770 to 0.8740.
• USD/CAD is up from 1.1140 to 1.1150.
• NZD/USD is down from 0.8275 to 0.8245.

Background

The Fed made the historic change in policy on December 18th by announcing QE tapering of $10 billion. The prospects were for a total end of QE by the end of 2014.

According to purchasing managers’ indices, retail sales and various other measures, the recovery in the US continues at a steady pace, and is getting ready to walk on its own. The only thing that could have slowed it down was the Non-Farm Payrolls report, that showed a gain of only 74K jobs in December. Nevertheless, this was eventually shrugged off by the markets.

One of the reasons for markets to shrug it off was the music coming from the Fed: various FOMC members seemed to support further tapering. Even a dovish member Narayana Kocherlakota hinted he wouldn’t vote against another taper.