Don’t Sweat the Fed

The chance of a market-moving surprise from the Fed is negligble

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Don’t Sweat the Fed

As important as Federal Reserve policy has been for the markets in recent years, at this point it should a low priority on investors’ list of concerns.

That may sound like an outrageous assertion until you consider the question: What can the Fed actually do to surprise the markets?

The baseline expectation for Fed policy right now is that the central bank will wind down quantitative easing gradually and wrap up the program by October. This could go two ways: Either economic growth will slow somewhat and the Fed will drag out tapering longer than expected, or growth will pick up steam and bring about a more rapid end to tapering.

Either case presents a fairly favorable backdrop for the markets.

In reality, however, it would probably take extraordinary circumstances to prompt the Fed to deviate from its current course. And since the Fed is in a reactive mode (also known as being “data dependent”), the markets will see the impetus for a shift well before the central bank adjusts its policy.

For individual investors, this means that there’s little value in trying to handicap the Fed’s next move regarding QE — or paying too much attention to the type of noise that followed the Fed’s tapering announcement on Wednesday afternoon.

When Will the Fed Raise Rates?

Tapering isn’t the only issue making headlines, since the largest variable regarding Fed policy is the timing of its first increase in short-term interest rates.

Those who follow the financial media will have noticed a growing drumbeat of discussion about this topic in recent weeks, and the fed funds futures market shows that investors are factoring in the possibility of rate hikes — however modest — early in 2015. The CME website offers this page, which shows the probabilities of various levels for the fed funds rate on specific dates. As of Wednesday afternoon, the January 28, 2015, contract was showing a 19% chance that the Fed will have raised rates by that date. The odds of a Fed rate hike by various other dates in the contract series are show in the table below.

Contract Expiration Implied Odds of Fed Rate Hike (as of 1/30)
March 31, 2014 0%
January 28, 2015 19%
March 18, 2015 25%
April 29, 2015 39%
June 17, 2015 49%
July 29, 2015 65%
September 16, 2015 76%
October 31, 2015 89%

A 19% chance is fairly low on an absolute basis, and part of this number likely reflects hedging by fixed income managers. Still, these odds  seem too high, considering the Fed is clearly stating its intention to keep rates at their current 0-0.25% level well after quantitative easing is wrapped up. In its statement on Wednesday, the FOMC said the following: “The Committee today 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.”


Article printed from InvestorPlace Media, http://investorplace.com/2014/01/fed-policy-markets/.

©2014 InvestorPlace Media, LLC

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