The FOMC Is Split

By Nicholas Jasinski | Wednesday, July 7

A Fed Divided. The Federal Reserve's policy committee's June meeting sent a shiver through markets, as officials acknowledged the faster-than-expected pace of the economic recovery and predicted a sooner tightening of monetary support. The minutes from that meeting were released this afternoon.

They showed a split on the Federal Open Market Committee, wrote Barron's Alexandra Scaggs: "Some officials said they expected to start winding down bond purchases earlier than they previously thought, while others wanted to wait. That followed labor data showing that fewer workers quit their jobs in May, and that a projected increase in job openings wasn’t as large as expected."

Officials said that "substantial further progress" on reducing unemployment and the economic recovery was still necessary before taking the Fed's foot off the gas pedal. But several saw an earlier than previously anticipated start to that process.

August or September has emerged as the consensus prediction for when the FOMC may lay out its bond-purchase tapering plans. That tightening could then begin early next year.

Here's Stephen Stanley, chief economist at Amherst Pierpont, writing this afternoon:

My own view is that it is a major development that the FOMC, at the June meeting, finally seems to be fully acknowledging the extent to which the economy is overheating. Even though many of the bottlenecks are expected to dissipate over time, I would argue that we have rarely seen a time when Fed policy has been more out of tune with current economic conditions. 

Imagine if the Fed could come at the asset purchase question fresh.  Could the committee make a credible argument, based on what is happening in the economy right now, that the Fed should be buying assets at all, much less at a massive $120 billion per month pace? No way.

We have now reached a critical point. The temporary bulge in inflation that the Fed expected at the beginning of the year, which was mostly a matter of basis effects, should be over. Thus, every additional month that inflation continues to run at a pace far in excess of the Fed’s target, officials are going to have to recalibrate. This is why I suspect that taper is more likely to begin sooner than later.

As for the beginning of interest rate increases, the minutes underlined that that is likely to be a 2023 event now. It's a year earlier than officials had been predicting before last month's meeting.

And yet, long-term U.S. Treasury yields continued to move lower today, as the prices of the securities rose. The 30-year bond yield broke below 2% yesterday, and held that level today. The 10-year yield settled at 1.32%, down from 1.75% in early May.

That trend continues to be a head-scratcher. Bond yields should be moving higher if the market is moving to price in higher rates sooner.

Nevertheless, lower bond yields are a tailwind for stock prices. Meager yields make stock dividends appear more attractive by comparison, and boost valuations thanks to a lower discount rate for future earnings.

The Dow Jones Industrial Average added 0.3% today, the S&P 500 rose 0.3% to a record high, and the Nasdaq Composite ticked up 0.01%, enough for an all-time high close.

DJIA: +0.30% to 34,681.79
S&P 500: +0.34% to 4,358.13
Nasdaq: +0.01% to 14,665.06

The Hot Stock: Oracle +3.6%
The Biggest Loser: Xilinx -4.7%

Best Sector: Materials +1.0%
Worst Sector: Energy -1.6%