Fed Talk is Cheap

By The Greek:

Stocks were higher Wednesday despite a sharp downward revision to Q1 GDP and another report of decreased mortgage activity on spiking interest rates. The catalyst for stocks was some soft comments from Minneapolis Federal Reserve Bank President Kocherlakota and others. Well, talk is cheap; the action of the Federal Reserve to pull away its asset purchase programs prematurely speaks louder than words. As a result, I do not expect this latest support to hold unless it is followed by a change in policy.

Security	June 26 Change
SPDR S&P 500 (NYSE: SPY)	+1.0%
SPDR Dow Jones (NYSE: DIA)	+1.0%
PowerShares QQQ (Nasdaq: QQQ)	+0.9%
Bank of America (NYSE: BAC)	+0.7%
iShares Dow Jones US Real Estate (NYSE: IYR)	+1.5%

How desperate must traders be to be bidding up stocks on some contradictory comments from a regional Federal Reserve Bank representative when the truth about the economy shows it’s not as secure as the FOMC believes it to be?

The Truth

First quarter GDP was revised significantly lower this morning in its third revision, which usually does not bring with it major change. I’ll leave it to the reader to run the regression analysis to prove this, and trust in my own observations over the last lifetime on this one. GDP is revised several times, and so by the third revision not much change is typical. Yet, Q1 GDP was cut to 1.8% growth from its recent reporting at 2.4% (that is a big difference for the mathematically challenged). The revised growth rate is consistent with the expectations of the World Bank and Conference Board for the U.S. economy this year, but less perfectly matched with the latest Fed view for 2.3% to 2.6% growth. Furthermore, judging by the trend over the last three Fed prints on this, the Fed’s economic forecast will be cut to 2.0% to 2.6% at next printing, in my view. Eventually, it might even make sense.

In its economic report the government stated: ”The GDP estimate released today is based on more complete source data than were available for the "second" estimate issued last month. In the second estimate, real GDP increased 2.4 percent. With the third estimate for the first quarter, the increase in personal consumption expenditures (PCE) was less than previously estimated, and exports and imports are now estimated to have declined.”

Add to that sour news the fact that mortgage rates spiked even higher last week, as reported by the Mortgage Bankers Association (MBA) today. For the week ending June 21, the MBA indicated that its Market Composite Index for mortgage activity fell by 3.0% to its lowest level since November 2011. Mortgage rates spiked last week after the Federal Reserve’s press conference announcing the tapering plan for the asset purchase programs. Here’s what happened to rates in the latest week:

Mortgage Loan	Rate	Change
30-Yr. Fixed Conventional	4.46%	+29 Basis Points
30-Yr. Fixed Jumbo	4.52%	+29 BPS
30-Yr. Fixed FHA Sponsored	4.20%	+35 BPS
15-Year Mortgage	3.55%	+25 BPS
5/1 ARMS	3.06%	+25 BPS

Perhaps not so surprisingly, Purchase Activity actually increased in the latest reported period, as some buyers on the fence rushed to lock in as low a rate as they could. Some believe rising rates will increase mortgage activity, and while I agree this could be a short-term phenomenon, it will not be a long-lasting sustainable economic positive or a catalyst for growth in the housing market.

So why then are stocks rising counter to intuition?

Fed Speak

Minneapolis Federal Reserve Bank President Narayana Kocherlakota wanted to clarify what he thought was a misinterpretation of the market since the FOMC Monetary Policy release and press conference. So on June 24, he published this clarifying statement and held a conference call to discuss the issue. He also appeared on CNBC this morning to discuss the issue, where I believe he caught the market’s attention.

President Kocherlakota’s statements were meaningful, mostly because they seem to give the Fed an out of this horrible trajectory it has decided on. The fact that this event occurred showed that there is some pressure on the Fed today about how markets have digested the message. Therefore, it may eventually react to stop the trend in mortgage and interest rates, hopefully in time to stop serious economic damage. But until it does, none of this matters.

The market believes the Fed is acting prematurely and taking away a critical support from the real estate recovery and from the still vulnerable economy. Interest rates will continue to rise as a result and the Fed thus destroys its own economic work. Talk is cheap, and actions speak louder than words. So the Fed should accept that the efficient market has spoken and that it was a mistake to taper asset purchase programs over the near-term, period.

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