I have never seen such bearish language used out of the Fed. Words or phrases like inflation “moderated”, indicators suggest “deterioration”, spending has “flattened out”, growth is “considerably” lower and “downside” risks to economic outlook. Further, the veracity of the statement that the “Fed is to keep rates at record lows AT LEAST through Mid-2013 is perhaps most shocking and powerful. The Fed understands the gravity of the words it chooses and the consequent extrapolation from the Fed watching and analytic community.
The Fed just basically announced “recession” and has consequently lowered rates REAL TIME and even set parameters for negative rates. There was some empirical analysis PRIOR to S&P downgrade which suggested historical tendency (not tendency forecasts) of rates to be 50 bps to 70 bps lower after an industrial sovereign downgrade like Japan, Canada, Australia and others. We were surprised at all the news conferences harping on the political save egg on face conclusions of lower rates yesterday. Many, not all, were looking for it. We are humble given volatility as no one has the answers.
Today, the curve originally ratcheted steeper as the front end extrapolated the 2013 language and by contrast the long end was left behind. The market, I think, then realized that this is a deflation/recession announcement by the Fed and it really is constructive for the long end. Until the equity response.
The equity response is positive as the Fed is FORCING grandmas and anyone who relies on a fixed income into alternative higher yielding asset classes. Dividend paying stocks look delicious. Convertibles, OMG, as you get a higher yielding fixed income instrument with a free equity option? EQUITIES and other perpetual assets that are being discounted by these rates. Pension funds use the lower rates to discount valuations.
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