Federal Reserve Wednesday, April 30, 2014

Trend Macrolytics, LLC Donald Luskin, Chief Investment Officer Thomas Demas, Managing Director Lorcan Roche Kelly, Europe Research Affiliate Data Insights: Federal Reserve Wednesday, April 30, 2014

Today's FOMC statement: how the language changed from prior meeting

Release Date: March 19April 30, 2014

For immediate release

Information received since the Federal Open Market Committee met in JanuaryMarch indicates that growth in economic activity has picked up recently, after having slowed sharply during the winter months, in part reflectingbecause of adverse weather conditions. Labor market indicators were mixed but on balance showed further improvement. The unemployment rate, however, remains elevated. Household spending and businessappears to be rising more quickly. Business fixed investment continued to advanceedged down, while the recovery in the housing sector remained slow. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Inflation has been running below the Committee's longer-run objective, but longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.

The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in AprilMay, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $20 billion per month rather than $25 billion per month rather than $30 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $25 billion per month rather than $30 billion per month rather than $35 billion per month. The Committee is maintaining its existing policy of 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. The Committee's sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term

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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.

The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. If incoming information broadly supports the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. However, asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

With the unemployment rate nearing 6-1/2 percent, the Committee has updated its forward guidance. The change in the Committee's guidance does not indicate any change in the Committee's policy intentions as set forth in its recent statements.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Richard W. Fisher; Narayana Kocherlakota; Sandra Pianalto; Charles I. Plosser; Jerome H. Powell; Jeremy C. Stein; and Daniel K. Tarullo.

Voting against the action was Narayana Kocherlakota, who supported the sixth paragraph, but believed the fifth paragraph weakens the credibility of the Committee's commitment to return inflation to the 2 percent target from below and fosters policy uncertainty that hinders economic activity.

Source: FOMC, TrendMacro analysis

Fedspeak regime change: the evolution of forward guidance

11% "

10%

9% UE Rate

7% consistent levels -

6% Funds rate target 5%

4% after after mandate

2013" 2015" - 2% - Core PCE inflation, YOY

"Sometime

"Patient"

"Considerable period" "Considerable

"Till UE 6.5%" UE "Till

"To mid "To "To mid "To

"Some time" "Some

"Well past 6.5%" past "Well

"Extended period" "Extended

"Measured" "To late 2014"late "To 0% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: FOMC, Federal Reserve H.15, BLS, BEA, TrendMacro calculations

Other voices: number of FOMC decision dissents — Dovish — Hawkish — Procedural

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: FOMC, TrendMacro calculations

Yellen's Evans Rule: When will the Fed start hiking rates?

— Unemployment rate    Trend from peak — Core PCE inflation YOY    Trend from trough

11% 2.5%

10% Inflation at "Evans Rule" 1.33%, Aug 2.0% 9% 2014

"Full employment" 8% inflation 1.22%, Jan 1.5% 2016 7%

6% "Full employment" 1.0% range 5.2% to 5.6%, 5% "Evans Rule" 6.5%, Aug 2014 Jan 2016 4% 0.5% 2007 2009 2011 2013 2015 2017

Source: BLS Current Population Survey, TrendMacro calculations

— Yellen's Taylor Rule (per Rudebusch 2009): Is the Fed tight or loose? Rule: 2.07 + 1.28 x 12-mo core PCE inflation - 1.95 x (UE - CBO natural rate) — Actual funds rate ···· Balance sheet-augmented funds rate

10%

6% 1.94% 4%

0% 0.13% -2%

-4% -4.34% -6% 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Source: BLS, BEA, TrendMacro calculations

Tracking the "dotplots" FOMC participants' estimate of "appropriate" target fed funds rate  Vote by individual participant For year-end 2015

3.5%

3.0%

2.5%

2.0%

Weighted avg Weighted avg Weighted avg 1.5% 1.25 1.06 1.06

1.0%

0.5%

0.0% Sep 13 FOMC Dec 13 FOMC Mar 14 FOMC

For year-end 2016

4.5%

4.0%

3.5%

3.0% Weighted avg Weighted avg Weighted avg 2.28 2.5% 2.26 2.18

2.0%

1.5%

1.0%

0.5%

0.0% Sep 13 FOMC Dec 13 FOMC Mar 14 FOMC

Source: Federal Reserve, TrendMacro calculations

Forecast versus actual: economic projections of the FRB and the presidents — Forecast  Actual  for 2009  2010  2011  2012  2013  2014  2015 Unemployment

11%

10%

5% 2008 2009 2010 2011 2012 2013 2014

Core PCE inflation

2.5%

2.0%

1.5%

1.0%

0.5% 2008 2009 2010 2011 2012 2013 2014

Real GDP

5% 4% 3% 2% 1% 0% -1% -2%

2008 2009 2010 2011 2012 2013 2014 Source: Federal Reserve, BEA, BLS, TrendMacro calculations

How much of the US stock market is effectively owned by the Fed? S&P 500 change from January 2009, USD billions — Market cap — Fed balance sheet risk equivalent

QE1/CE2

QE2 QE3

CE1

QE1.1

QE2 endsQE2 QE1 endsQE1 2nd taper

Op twistOp

Taper

3rd taper3rd CE CE ends +$10,000 3.1 Twistends/QE +$1000 +$9,000 +$900 +$8,000 +$800 +$7,000 +$700 +$6,000 +$600 +$5,000 +$500 +$4,000 +$400 +$3,000 +$300 +$2,000 +$200 +$1,000 +$100

-$1,000 -$100

Source: Bloomberg, TrendMacro calculations

Actual and projected Fed LSAPs (Large-Scale Asset Purchases) vs. Treasury yield Projected at current run-rates

$4,500 6%

$4,000

QE1.1

QE1/CE2

QE3 Today QE2

CE1

CE CE ends

OT OT ends

QE1 endsQE1 QE2 endsQE2 Op twistOp

Taper beginsTaper 5% $3,500 Agencies 10-year yield $3,000 MBS 4% $2,500 10 years plus $2,000 3% 5 -10 years $1,500 0-15… 91 days to 1 year 1 -5 years $1,000 16-90 days 2%

$500

$0 1% 2007 2008 2009 2010 2011 2012 2013 2014 2015

Source: Federal Reserve H.4, H.15, TrendMacro calculations

The Fed's assets, and how they are funded (USD billions) Assets do not perfectly match liabilities because we include unsettled MBS purchases and sales

$4,500 Total Total $4,380 $4,340 Assets Liabilities

$4,000

Year Year ago ago

$3,500 $3,439 $3,361 $2,331

$3,000 Treasuries

Fed 19%

$2,500 $2,458 Other Ownership of 81% US federal debt

$2,000 Excess Excess reserves

$1,500

$1,679 $126

$1,000 MBS

$1,271

$257

Currency

$63

$46

Required reserves Required

$8 $0

$500 $33

$45

$150

Reverse repos Reverse

$216

$11

Other cap Other liab,

$11

Agencies

Treasury Treasury currency

Misc

Other Other assets

TSLF

Treasury

Gold

Swap lines Swap

Misc

SDR certificates SDR

Repos TAF

Maiden Lane Maiden III TALF MaidenLane

Other Other credit CPFF AIG window Discount

ABCPMMLF PDCF Lane Maiden II

MMIFF MMIFF

Term deposits Term SFP

Other Other deposits AIG AIG accrual $0 Source: Federal Reserve H.4, US Treasury, TrendMacro calculations

Money supply growth, YOY quarterly — M1 — M2 — Monetary base

110% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% -10% 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13

Source: Federal Reserve H.6, TrendMacro calculations

Monetary velocity, quarterly — M1 base multiplier ---- M1 output multiplier — M2 base multiplier ---- M2 output multiplier

14x

12x

10x

0x 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13

Source: BEA, Federal Reserve H.6, TrendMacro calculations