Benny and the Feds

Posted by on Jun 21, 2013

Last Wednesday, the minutes from the most recent meeting of the Federal Open Market Committee (FOMC) were released. Almost immediately after their publication, the market did a zero-g dive in the hour remaining in the trading day. (A zero-g dive in an aircraft gives you a feeling similar to the one you get when you’re in a roller coaster and it does that move downhill after a long climb – the bottom drops out and you’re forced up out of your seat…exciting, though occasionally disconcerting.)

After the market closed that day, Mr. Bernanke held his usual post-release press conference. The interpretation of his comments by market participants led to Thursday being a continuation of Wednesday’s downward move. It was the worst single trading day of the year, resulting in a drop of 353 points in the Dow (2.3%), with similar percentage drops by the NASDAQ and S&P500 and the yield on the 10 year US Treasury note rising to a 14 month high of 2.51%. (1)

What the heck was in that announcement and what evil spell did Ben cast on the markets? Glad you asked…

What they said

In the minutes, it was noted that the FOMC made some changes in its economic forecast. It reduced the real GDP growth for this year but added it into 2014. It projected that the unemployment rate by the end of this year would be about 7.25% (it’s 7.6% now (2)) and that it would be about 6.65% by the end of 2014. Inflation projections from now through 2015 were reduced. (3) Sounds pretty good so far, don’t you think?

Also included was this comment. “The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall.” (4) Again, that seemed okay.

In his presser, Mr. B spelled out what the proverbial bottom line is in his view. “The key point I’ve tried to make today is that our policies are tied to how the outlook evolves…we will be providing whatever support is necessary (to the markets)” and that “interest rate hikes are still far in the future.” (5)

Whatever support means if things weaken, they step up. If we continue to improve, they back out. Once again, seems logical to me.

Taper tantrum

About that “diminished from last fall” phrase. Interpretation of this was one of the major catalysts for the drop in bond prices that pushed the interest rates higher. That the economy would be stronger implies that an increasing demand for money will cause interest rates to rise.

Regarding the current buzzword du jour on Wall Street, tapering means the Fed will reduce its purchases of Treasury securities – the basis for quantitative easing – at some point on a gradual basis. Mr. B emphasized that the speed with which this will occur is totally dependent upon data, i.e., inflation rates and unemployment. Nonetheless, his actually having said that this could start by this year-end and done by about a year from now was another catalyst for rates rising. (6) This is because less Fed buying means less demand, resulting in bond issuers having to pay higher rates to attract money to their offerings.

Bonds going up in return makes them somewhat more attractive as an alternative for stocks – an additional point that helped move share prices down.

Good news is bad?

So, the Fed is saying that it sees the economy strengthening and unemployment dropping. Who doesn’t want that? The market, it would seem. As Jeff Kleintop, chief market strategist at LPL Financial, said on Thursday, “This feels like an overreaction. The Fed didn’t tell us anything we didn’t already know.” I agree with Jeff on both comments.

There’s no direct link between tapering and the tightening of interest rates. In their press release, the FOMC said that there would be a “considerable” time lag between the total ending of the easing program and the decision to raise the fed funds rate. (7) In the Fed translation book, “considerable” time likely means a period of about six to twelve months. And my guess is that they’ll do it in gradual quarter point increments. So, it doesn’t look as if rates are going up tomorrow nor are they probably going up all at once.

The challenge is that the financial markets are forward-looking. While I think the market action this past week suggests that the markets may be ahead of themselves right now, there’s a definite realization that what has worked for the past few years needs to be readjusted. I think Mr. B and the Feds did the market a big favor by eliminating a major point of uncertainty with this last release.

What about investing now

I believe that those who are the biggest worriers about the potential effects of the Fed’s plans – and, unfortunately, they seem to be the majority for now – only see that an “easing-free” economy will shrivel and die like a plant without water. The supporters of QE forever are the main purveyors of the good news is bad attitude. They cheer when economic reports are weak or unemployment rises as they think those kinds of reports will keep the money coming.

I firmly believe that when the economy does fine without the fiscal IV drip, it will be a surprise for the majority – and positive surprises tend to move the markets higher.

Ward McCarthy, chief US financial economist at Jefferies & Company, has my back on this. He came out Friday with four reasons to be positive on stocks now. His reasons are, “continued job growth, an improving housing sector, high growth potential in energy and manufacturing that is poised for recovery.”

I also have Joe LaVorgna, chief US economist at Deutsche Bank, in my corner. He said on Friday that ,“The general economy is pretty darn healthy. With stupidly low levels on yields on Treasury notes, equity prices will go higher.” He added that, “It’s not like a lot of money went into stocks to begin with. All the money went into fixed income – that’s why you’re seeing the dislocations.”


All market transition periods are bumpy. Since we’ve had the Fed’s training wheels on the recovery for a while, we’re bound to be a little wobbly as we get used to moving without the security of that support. Our rising interest rates are due to this gradual lifting of uncertainty, along with a steadily improving economy. It’s usually not the end of the world when rates are rising gradually as stocks generally tend to do okay.

Understand that as we have this recovery, one definite result will be a fair amount of pain in the bond markets. We’ve only seen the beginning of that these past few days. As rates rise, prices of existing bonds drop. When you get your next quarterly statements showing fixed income positions, it’s highly likely you will see losses – just due to this bond math. You may want to consider shortening the duration of your holdings to help reduce your principal risk.

I don’t see this coming period as being anywhere close to the end for a positive stock market. We may be pausing, but that’s it. I think we’ll see volatility start to drop again as this recalibration of portfolios and “normalization” of interest rates work their way through the markets. Historically, in such markets as these, stocks in the cyclical sectors have tended to do well.

Let me close with a quote from a pretty astute market observer named James Paulsen. He’s chief investment strategist at Wells Capital Management. He said Thursday that Mr. B’s comments were a “mark of success” of the economic recovery. He went on to say that, “When the Federal Reserve chairman has to stand up and tell the American public that they (the Fed) think this economy can stand on its own and we can scale back our help, I think for an equity investor, that’s a good thing.”

What he said…




  1. CNBC
  2. Bureau of      Labor Statistics
  3. Board of      Governors of the Federal Reserve System meeting notes, 19 June 2013
  4. Ibid.
  5. Ibid.
  6. Ibid.
  7. Ibid.

To get an overview of economic conditions, use this link. It’s updated monthly.

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Michael J. Maehl, CWM®

Senior Vice President

Opus 111 Group LLC

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