What FOMC Would Do?

We all have seen how the markets have behaved on the back of the FOMC's comments. There is too much to read for the markets and the investors in the FOMC statement. The main reason behind this is the global liquidity would come under pressure if Fed decides to end the ongoing Quantitative Easing- 3 program. Currently FOMC is purchasing mortgage-backed securities at a rate of USD 40 billion per month and longer-term Treasury securities at a rate of USD 45 billion per month.

In the earlier meeting the Fed has kept markets guessing what Fed would be doing. The question is not 'Will Fed end the QE' but is 'When Fed will stop QE'?. The unemployment rate and housing data has been Fed's key focus areas. Besides it is also keeping watch on Household spending and fixed investments by businesses. European economy has also eased from the lows of 2012 meaning slowly the advanced economies are coming back to normalcy. Japan has already reported expansion in GDP in recent quarter.

In the earlier three meetings of the FOMC, it acknowledged that the employment rate is rising slowly but the unemployment rate remains well above its comfort zone. It also has said that household spending and fixed capital investments are rising. The housing data is also showing an improvement. As the leading economic indicators indicate improvement in the US economy, there is a talk of tapering or ending QE 3.

If one looks the key indicators then the US economy is really showing a strength. The ISM manufacturing index has continued showing expansion in 2013.  Non Manufacturing index is also showing consistent expansion in 2013. Trade deficit is also declining and recently dollar has also gained strength.

On the housing front, Construction PMI numbers are showing improvement and the latest data has come better than expected. New home sales are rising as per the data available until April 2013. This also means that the May data would also come positive. US NAHB Housing Market Index which indicate the confidence of the respondents, rose to 52 in June from 44 in May. Overall the housing markets seems to be coming back back in good shape and hence the US economy, going forward may further shown faster recovery.

On the labor front, Continuing Jobless Claims have declined from the earlier levels which indicate that the people are able to find full time jobs which has led to the decline in the jobless claims. Initial Jobless Claims are at lowest point in the last five years and have maintained a downward trend. The unemployment which remains a decisive point for Fed to end QE has also shown an improvement.

Unemployment rate peaked to 10.2% in June 2009 but now stands at 7.5%. That's still 100 basis points above the FOMC's comfort level. If one considers that the unemployment rate has declined about 70 basis points every year, then it could take just over a year to touch the level of 6.5%.

We believe that FOMC may not take a decision to taper or end QE at this time. However there would be growing split within the FOMC members to end the Q3 soon.

Markets would remain cautious on this as the sooner or later QE will end.