What spooked the Fed?

The Federal Open Market Committee (FOMC) stunned markets this week by choosing not to cut back on its asset-buying program. Stimulus-thirsty investors rejoiced: not only was their proverbial punchbowl not taken away, it was refilled.

Global stock markets and bond prices surged while the U.S. dollar tumbled as the world’s most influential central bank decided not to proceed with what was thought to be a well telegraphed September taper. Citing an economy and labour market that are only modestly improving, the Fed decided to maintain its current policy of zero interest rates and $85 billion of monthly asset purchases, at least for now.

Perhaps the main consequence of the no-taper decision is that it likely now puts more of the unwinding decision onto the shoulders of Bernanke’s yet to be named replacement. His term ends in January 2014.

Read: Fed doesn’t taper

The run up in bond yields since May is likely what really spooked the FOMC. Higher rates pose a threat to the U.S. housing recovery. Following the ‘no taper’ news, bond prices rose with the yield on US10-year notes falling the most in one day since August 2011. How long yields stay at these lower levels will, as they say, be dependent on the economic data.

We hate to rain on a good party but perhaps the Fed’s weaker read on the U.S. economy should be a bit sobering to investors since the gap between rising valuations and the economic fundamentals remains wide and may in fact be growing.

QUESTION OF THE WEEK

This week, the Federal government and the provinces of Ontario & British Columbia signed on for a national co-operative securities regulator to administer a single set of capital markets rules for Canada. Hasn’t this failed before and how is it different this time?

Back in 2011, the Supreme Court of Canada ruled that the federal government does not have the power to create a national securities regulator. The proposed Canadian Securities Act was an effort by the Federal government to replace the current patchwork system of rules created by 13 separate regulators.

Read: National securities regulator not dead: CFA Institute

A number of provinces, including Quebec and Alberta, were opposed, arguing the current system is working just fine. In its 2011 ruling, the Supreme Court did note that a “cooperative approach” where the provincial nature of securities regulation is recognized while allowing Parliament to deal with criminal and systematic concerns remained a viable option. It was that ‘co-operative’ option that was agreed to by Ontario, B.C., and the Federal government this week. Alberta and Quebec still remain opposed.

The other provinces and territories are expected to sign on to the co-operative since a key part of the announcement is a pledge by the federal government to provide transitional funding for provinces to compensate them for revenue they will lose from the fees charged by their securities regulators. Instead of provinces ceding control over securities to the federal government and a new national securities act being passed to regulate the sector, the new model will see each province pass matching legislation to retain ultimate legislative authority over the sector.

Canada is the only developed country in the world without a national securities regulator. The decision to forge ahead and establish a national securities regulator is both feasible and desirable for about two thirds of the Canadian capital markets with Ontario and B.C. on board. The proposed new system would help attract more investment, better protect investors, make it easier to prosecute white collar criminals and manage systematic risks to the financial system.

The current system of provincial and territorial regulators is bogged down by the need to gain consensus among multiple jurisdictions, inconsistent rules of enforcement and inefficient compliance costs. It remains to be seen, however, which provinces will cooperate with the federal government and, if so, on what terms. The regulator is expected to be up and running by 2015.

Read: Five reasons for a national regulator

David Andrews is the Director, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends. @David_RGMP