The Federal Reserve wrong-footed the markets. Confounding widespread expectations, the bond purchasing program will continue unchanged. Although the Federal Open Market Committee acknowledges underlying improvements on the labor market – pivotal for adjustments in its bond purchases – it currently also identifies a number of risks regarding the sustainability of this trend. On the one hand they point to the tightening of financing conditions in recent months that could curb growth momentum and the improvement on the labor market. On the other, Fed chairman Bernanke also highlighted the risks to the economy and the financial markets in conjunction with still unresolved fiscal challenges. It is indeed still unclear under what terms the political parties will be able to reach agreement on the funding of the fiscal 2014 budget (which starts in October) and a raising of the government debt ceiling (required by mid-October).
With its latest decision the Fed has squandered the opportunity to start gradually reining in bond purchases without causing shock waves as, following Bernanke’s hints in June, the markets had already largely priced in such a move. Now an even swifter reduction might be necessary in the coming months.
Assuming that the government and Congress manage to reach budgetary compromises (in time), the US economy is likely to firm up clearly in the coming months – a picture also confirmed by the Fed’s updated macroeconomic projections. In this context it is also worth noting that homebuilders have so far not assessed any drop-off in home purchases despite the rise in mortgage rates. Against this backdrop a tapering before the year is out still looks possible. A sustained reversal on the US bond market with substantially lower yields therefore seems unlikely.