Fed Speaks, Traders Sell

You know this feeling…

You’ve been waiting for a package all day, keeping one eye out the window for that little white truck. Then the mailman comes… he’s got a box! He’s at the door. Ding-dong! Sign here, please. You hurry the package inside and rip open the box with a crude combination of car keys and brute strength. The packing peanuts spill out and the contents are revealed. You grasp your prize with both hands…

Crap. This is what you ordered, but not what you thought it would be. The color’s off. Size isn’t right. Euphoria is slowly replaced by doubt… then disappointment… and finally frustration. Now you’ll have to go about undoing this mishap, and the process of shipping it back and battling with customer service makes you quietly wish you never ordered it in the first place.

If you haven’t picked up on our metaphor yet, here’s a hint:

Market Reacts to Fed Announcement

So what got traders in such a tiff? Heh, we could think of a couple different things. First, here’s the quick-and-dirty version of the Fed’s announcement:

  • “Economic activity has picked up following its severe downturn,” but “economic activity is likely to remain weak for a time”
  • The Fed will continue its plan to buy $1.5 trillion in mortgage-backed securities. They’re now looking to end this program in the first quarter of 2010, later than originally planned
  • Planned purchases of Treasuries will be completed by October, at a cost of $300 billion
  • Rates stay at near zero and will stay “exceptionally low” for “an extended period”
  • “Inflation will remain subdued for some time.”

“Investors figured out,” says our friend Chuck Butler, “that by leaving the stimulus in place longer than originally planned, the Cartel, I mean the Fed, is confirming that the U.S. economic recovery isn’t nearly as robust as Big Ben and his compatriots have led everyone to believe. Stock markets fell and the Treasury rates rose. With the stocks backing off, the risk assets of currencies and precious metals backed off VS. the dollar.”

The mere thought of the Fed leaving the mortgage-backed security market likely caused much of the stock sell-off too. Bernanke and his brood have been relentless consumers of the housing-backed garbage this year:

Fed Purchases of Mortgage Backed Securities

Of the $8.9 trillion mortgage-backed securities market, the Fed will own almost 17% of ’em when it’s all said and done. Of MBS issued since the recession began, The New York Times says the Fed owns up to 80%.

So now the Fed says it wants out by March 2010 — right at the time, we hasten to add, that the infamous second wave of ARM resets (link) is supposed to crash ashore. When the Fed abandons this binge, who will belly up to the bar and take their place? Will the Fed then become a net seller, or will it just let these toxic assets rot on their balance sheet? How could mortgage rates possibly stay so low? Maybe we’ll have to choose between another MBS crisis or selling the U.S. housing market to China… assuming they even want to buy it.

The Daily Reckoning