After much speculation in early June as to when the Federal Reserve would let up on its quantitative easing policy, Fed Chairman Bernanke finally spoke… and the markets overreacted with both stocks and bonds taking a hit in the face of indiscriminate selling.
Chairman Bernanke carefully couched his announcement on June 19, noting that the pull-back is expected to start later this year, and that the Fed will scale down monthly purchases of Treasury securities and mortgage-backed bonds gradually beginning later in 2013 and ending when the unemployment rate reaches 7 percent (which the Fed projects to be around mid-2014 ). He emphasized that the timing of the pull-back would be contingent upon the economy, and that if growth falters, the central bank would slow or even reverse its retreat. Despite a host of provisos and disclaimers, traders reacted as if Bernanke had yanked the rug out from under them.
Bear in mind that all this reaction was to a speech; the Fed has not made any changes nor set any timetable to do so. The market’s dive illustrates the power that the Federal Reserve wields over the mindsets of investors, traders and economists. When they established the central reserve system 100 years ago in 1913, the lawmakers who set it up could have hardly anticipated the power the Fed yields today. Until the Fed’s recent policy meeting, the stock market had been performing extremely well. The Dow Jones Industrial Average was up 20 percent since the beginning of the year, and at 15,542, the Dow had set a new record high. Bernanke’s comments, which came after a two-day policy meeting in Washington, apparently rattled Wall Street gurus who preferred that any QE let-up be pushed back into a more nebulous time frame.
A look at what Chairman Bernanke actually said during the press conference should reassure the most nervous investor that the Fed intends to move very carefully in order not to disturb the economic progress that has already been made. Unwinding the stimulus campaign slowly is expected to take several years. The Fed expects to continue for now to buy $85 billion of bonds per month in Treasury securities and mortgage-backed bonds, and to hold short-term interest rates to near zero.
Following a couple of jittery days, investors began to calm down. After taking quite a hammering in the wake of Bernanke’s remarks, both the DJIA and the Standard & Poor’s 500 rebounded toward the end of June.
In a separate news release, the Federal Reserve announced that it expects unemployment rates to drop more quickly than they had predicted – reaching between 6.5 percent and 6.8 percent by the end of 2014. The Federal Reserve has noted, in another statement, that the economy was expanding at a moderate pace and that risks to growth had diminished – an important observation because the Fed had been attempting to protect the economy from the effects of government spending cut-backs.
With good news on the housing front and polls showing consumer confidence rising, investors have much to celebrate. As the knee-jerk reactions over Bernanke’s speech subside, perhaps we will sail into calmer waters in July.
The above is intended as general commentary only and should not replace the counsel of professional tax and investment advisors.