by Ed Elfenbein | June 16, 2013 8:00 am
The Federal Reserve meets next week, and this meeting will be a biggie. I’d love to be a fly on the wall (and maybe NSA will have some flies on duty), but the minutes from the meeting won’t be released for another three weeks.
We’re at an interesting time for the market because normally, the jobs reports and Fed policy statements are by far the most important economic events. But now, I’d say the release of the minutes of the Fed meetings has taken center stage.
Why’s that? It’s because investors are on the lookout for any sign that the Fed is going to wind up their massive bond-buying program. The stock market has clearly been aided by the Fed’s bond purchases. Heck, the Fed even said that was one of their intentions. But I think some investors believe the entire rally has been due to the Fed’s pulling the bull along. That’s a giant overstatement. But you don’t have to go far on Wall Street to find folks who think: no Fed help, then sell everything you got. They’re wrong, but they can cause us headaches.
My position had been to ignore this fear-mongering. I didn’t think the Fed was even close to considering a change in its policy before the end of the year. I still believe the Fed shouldn’t make any changes until the moribund jobs market gets better or inflation starts to heat up, and there’s no sign of that happening. But, for some strange reason, I’m not allowed to vote on the Federal Open Market Committee.
I’m now concerned that the Fed may start tapering off their bond purchases before the year is out. What happened to change my thinking is that last Friday, Jon Hilsenrath of the Wall Street Journal, who’s widely understood to be Bernanke’s go-to media conduit, wrote:
Federal Reserve officials are likely to signal at their June policy meeting that they’re on track to begin pulling back their $85-billion-a-month bond-buying program later this year, as long as the economy doesn’t disappoint.
Whoa. I didn’t see that coming, and that caught a lot of people’s attention. I, for one, am going to assume that’s Bernanke speaking. Note that he didn’t say they “will pull back,” but merely, “they’re on track to begin pulling back.” Of course, I can say that I’m “on track” for a lot of things. It doesn’t mean they’re about to happen. Still, the Fed wouldn’t be floating this in the media if they didn’t think it was important. So this is a big deal.
We also have to remember that the Federal Open Market Committee is just that—a committee. Bernanke is the head of it, but a majority can oppose him. It’s happened before. Despite Hilsenrath’s (cough cough Bernanke’s) article, I’m inclined to believe the Fed won’t make any changes just yet, but I can’t be sure. I suspect that there are some Fed members who think it’s time to end the buy-bonds frenzy. Perhaps Bernanke wants to adjust the language and spell out clear timelines to appease those folks.
Even if the Fed does start tapering off, I don’t subscribe to the view that the stock market is toast without the Fed’s help (and a lot of people do subscribe to such a belief). Let’s remember that there are some definite bright spots in the economy. The housing market is better, and budget deficits are shrinking. I think a key driver of what the Fed will do can be found in the Fed’s economic forecast. Hilsenrath notes that the Fed has been consistently over-optimistic about what I’ll generously call “the recovery.” The problem is that fiscal policy has been holding back the economy. At least, that’s Bernanke’s view. The economy is, so far, running behind the Fed’s forecast for 2013. So either the Fed will lower their forecast next week or they’ll double down and expect the economy to ramp up later this year. The stock market believes earnings will ramp up, too.
My overall view is that there’s a lot riding on this second-half recovery. If it indeed comes, a lot of problems will be taken care of. Investors are afraid of the Fed’s tapering off, which may not happen soon, and even if it does, there’s no reason to be so scared. My advice to investors is to stay focused on our Buy List stocks, but be prepared to see some volatility coming our way. If the market gets weak, it will be a great opportunity to buy, but don’t jump in just yet.
Earlier, I mentioned that the Federal Open Market Committee is in fact a committee. Well, there’s an unrecognized member of the committee who has the most important vote of all, and that’s the market. It’s interesting to note that the S&P 500 peaked in May at the exact time that Ben Bernanke told a congressional committee that the Fed could start winding down its bond buying.
Apparently, the Fed is scared that it’s scaring the market. So yesterday afternoon, just before the market closed, Hilsenranke came out with another article. In it, he conveyed the Fed’s caution to investors not to overreact to any adjustments to their bond buying. Easier said than done. It’s like a teenager calling his parents and opening with, “don’t overreact.” Whatever may follow, it probably ain’t good.
Again, I think these comments are coming right from Bernanke, and I understand his concern. The financial markets are clearly worried the party is about to end. The long end of the bond market is already factoring in higher interest rates, and that’s why interest-rate stocks lost favor.
But here’s the thing: This is really the same story we’re seeing in Japan, just not as dramatic. Investors think the Fed isn’t fully committed to propping up the market. The Fed has said that it won’t raise short-term interest rates until unemployment gets to 6.5%. We’re at 7.6%, which is a long way away. Most economists think that at best, we won’t get to 6.5% until 2015. Still, the futures market for interest rates expects increased rates before then. In short, that unrecognized voting member of the Fed might exercise its power of veto.
Interestingly, in last week’s CWS Market Review, I mentioned how “tapering” had become Wall Street’s favorite buzzword. Well, Hilsenranke had another article from last Friday saying that the Fed really hates the word “tapering.”
The hangup for Fed officials is the word “tapering,” which suggests a slow, steady and predictable reduction from the current level of $85 billion a month at a succession of Fed meetings, say to $65 billion per month, then to $45 billion and so on. And that’s not necessarily what Fed officials envision.
Because Fed officials are uncertain about the economic outlook and the pros and cons of their own program, they might reduce their bond purchases once and then do nothing for a while. Or they might cut their bond buying once and then later increase it if the economy falters. Or they might indeed reduce their purchases in a series of steps if warranted by economic developments — but they don’t want the markets to think that’s a set plan. It is, as Fed officials like to say, “data dependent.”
Hmmm. This strikes me as a bit pedantic. With interest rates, Fed policy almost always follows a trend. It stands to reason that bond buying will be similar.
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