Preferred Stocks Stand Out as the Taper Tiger is Tamed

by Richard Band | December 11, 2013 9:59 am

Marvel of marvels!  Just last Friday, the Labor Department reported a stronger than expected monthly jobs tally for November, and a drop in the unemployment rate to 7%.  Poison for bonds?  Not exactly.

This afternoon’s headline says it all:  TREASURIES CLIMB TO BEST LEVEL IN A WEEK.  Why, even poor battered gold managed to settle $31.90 an ounce higher on the Comex at $1261, basis the February futures contract.

Bonds and gold are rallying even as a consensus builds on Wall Street that, a week from now, the Federal Reserve will begin “tapering” its enormous purchases of bonds and mortgages.  How is all this possible?

Actually, it’s not such a mystery if you understand a little market psychology.  Markets tend to overanticipate events.

People have been talking about Fed tapering for almost seven months.  Bonds and gold have been marked down sharply in the belief (fear is more like it) that tapering would soon lead to an overt tightening of credit by the central bank.

However, numerous Fed spokespeople have made it abundantly clear that interest rates at the short end of the maturity spectrum—the only rates the Fed has much control over—aren’t going up anytime soon.  Finally, that message is sinking in.

Take a peek at the chart here[1].  It plots the December 2014 (that’s 2014, not 2013) federal funds futures contract.

“Federal funds” are short-term loans that banks make to each other through the Federal Reserve System.  The Fed carries out monetary policy by manipulating the federal funds rate.

Back in early September, as you can see, traders in the fed fund futures market were convinced that, by December 2014, the central bank would have raised this basic money rate to around 0.5%, from the present range of zero to 0.25%.  (The chart is scaled so that the fed funds rate is 100 minus the figure on the y-axis; thus, 99.50 means 100 minus 99.50, or 0.5%.)

Since September, those expectations of a rising fed funds rate have collapsed.  The Fed has convinced traders that the rate will remain exactly where it is for at least another year.

With the short end of the yield curve now firmly anchored at near-zero for the next 12 months, it’s only logical that courageous investors  are beginning to venture into higher-yielding, longer-dated IOUs.  While I’m still not particularly enthusiastic about Treasuries, I think it makes perfect sense to accumulate preferred stocks[2] in the current environment.

  1. here:
  2. accumulate preferred stocks:

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