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Catalyst: 'Monetary Cocaine' Withdrawal And Rising Rates

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PLANO, Texas (9/18/13)--Interest rates have been rising, and the value of credit union bond portfolios has been falling. But people have been talking about the inevitability of higher interest rates for so long that, for many, calling this a trend seems like just another false alarm, said Catalyst Corporate FCU.
"There are those who believe concerns over increasing interest rates are overblown, that the economy is not strong enough to sustain increases, and that long-term rates are bound to fall again," said Tim McWilliams, Catalyst senior investment officer and a registered representative for CU Investment Solutions LLC, in Catalyst's press release.
"Whether interest rates rise now, in six months or in a year, if a credit union has bought long-term fixed-rate bonds, it is vulnerable to a potential continued rise in interest rates," he said.
Richard Fisher, president of the Dallas Federal Reserve, described the current monetary environment as a market is on "monetary cocaine." The reference alludes to the Federal Reserve's $1 trillion-plus stimulus to the economy through monthly large-scale asset purchases in its quantitative easing program. When asked about the impact of rising bond yields on the economy, Fisher responded that policymakers could not let the markets dictate monetary policy.
"The Federal Reserve has been buying $85 billion a month in longer duration treasuries and mortgage-backed securities," said McWilliams. "These purchases have kept long-term interest rates at historically low levels, helping to revitalize the housing market and other sectors that rely on housing."
With the Fed saying it is 'broadly comfortable' with beginning to taper these purchases, many economists believe the Fed will decide to reduce the pace of the bond purchases as early as this month.  Its Federal Open Market Committee has been meeting Tuesday and today to determine the next step. (News Now will provide an update this afternoon on FOMC's statement after the meeting.)
"The mere hint of the Fed removing that stimulus has caused the rate on 10-year treasuries to rise from 1.62% on May 2 to the current yield of 2.9%," McWilliams said. "Whether the Fed begins to taper in September is anyone's guess. The Fed has made it clear it wants to end quantitative easing; it's just a matter of how much [the committee] will taper and how quickly."
Credit unions are prudent to consider whether the market has become "addicted" to low long-term interest rates, he said, adding, "If so, how bad will the withdrawal symptoms get? And without the Fed buying bonds, where will a free market reset long-term interest rates?" he asked.
Analyzing rising rate scenarios in a credit union's asset liability management model is the first step in positioning its balance sheet to respond to these withdrawal symptoms, said McWilliams. The second step is analyzing the credit union's investment portfolio to determine if portfolio strategy or individual holdings are putting the credit union at risk.
"Does your credit union have a properly diversified portfolio? Does it have a mixture of both long-term and short-term bonds? Does utilizing a larger portion of adjustable-rate securities to hedge your fixed-rate holdings make sense?"

McWilliams asked. "These are questions that credit union senior management needs to be asking now. It's time to reevaluate your balance sheet and investment portfolio and determine the potential implications."

Home Market Index Steady At Highest Level Since 2005

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WASHINGTON (9/18/13)--U.S. home-builder confidence in September is at the highest level in eight years, indicating that housing should remain positive for the U.S. economy, even though new signs have surfaced that show the housing market is losing some momentum (, The Wall Street Journal and Moody's Sept. 17).
The National Association of Home Builders (NAHB)/Wells Fargo confidence index remained at 58 this month--the same as in August--matching the best reading since November 2005, NAHB said Tuesday.
Readings greater than 50 indicate more builders see conditions as good than poor.
Although work orders received during the past few months will likely maintain gains in construction, more rapid growth in hiring and wages are necessary to prompt larger increases in consumer demand, Bloomberg said. 
The headwinds of tight credit, declining amounts of lots for development and rising labor costs are causing consumers to take a wait-and-see attitude, following a strong buildup of consumer confidence during the past year, David Crowe, NAHB chief economist said in a statement.

NEW: Fed Doesn't Reduce QE3 Spending, Maintains Interest Rates

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WASHINGTON (9/18/13, updated 2:50 p.m. ET)--The Federal Reserve's policymakers today again decided not to reduce its quantitative easing policy of buying $85 billion in Treasury bonds and mortgage backed securities, saying that although market conditions have improved somewhat, the "unemployment rate remains elevated." Instead, the Federal Open Market Committee "decided to await more evidence that progress will be sustained before adjusting the pace of its purchases."

The FOMC also decided to keep the targeted federal funds rate in the 0% to 0.25% range. Many had expected the Fed to announce today a token tapering of the bond buying, but others had said recent economic reports that were lower than expected would be a factor.

"Information received since the FOMC met in July suggests that economic activity has been expanding at a moderate pace," said FOMC's statement today, at the end of its two-day meeting.

"Some indicators of labor market conditions have shown further improvement in recent months, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen further and fiscal policy is restraining economic growth. Apart from fluctuations due to changes in energy prices, inflation has been running below the committee's longer-run objective, but longer-term inflation expectations have remained stable," the committee said.

The FOMC said it "expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the committee judges consistent with its dual mandate" of fostering maximum employment and price stability. It "sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall, but the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market."

It noted the committee "recognizes that inflation persistently below its 2% objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term."

Although it sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago, the committee said it will continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.  It also will continue reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.
"Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the committee's dual mandate," said the FOMC statement.

"In judging when to moderate the pace of asset purchases, the committee will, at its coming meetings, assess whether incoming information continues to support the committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective," the committee said, cautioning that "asset purchases are not on a preset course, and the committee's decisions about their pace will remain contingent on" its economic outlook as well as its assessment of the likely efficacy and costs of such purchases."

The committee also "reaffirmed" its view that a "highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens."

In keeping the federal funds rate at 0% to 0.25%, the committee "currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6.5%, inflation between one and two years ahead is projected to be no more than a half percentage point above the committee's 2% longer-run goal, and longer-term inflation expectations continue to be well anchored."

In determining how long to maintain that highly accommodative stance, the FOMC will consider other market information and when it decides to remove the policy accommodation, it will "take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2%."

Voting for the FOMC monetary policy action were: Fed Chairman Ben S. Bernanke; Vice Chairman William C. Dudley; James Bullard; Charles L. Evans; Jerome H. Powell; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action was Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations.
For the full statement, use the link.