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Fed Keeps Taper Right On Schedule

27 June 2014 in Trading Ideas

The Federal Reserve’s Open Market Committee concluded last week with a legitimate kernel of good news: the Fed said that economic activity has bounced back from a less-than-stellar first quarter, while labor market conditions seem to be improving.

On the other hand, because of that weak first quarter, the Fed took down its expectations for full-year economic growth to 2.1%-2.3% from its prior projection of 2.8%-3%.1

And, although interest rates have been slipping modestly throughout 2014, this week they were sitting right near their 50-day average, and Fed Chairwoman Janet Yellen reiterated the great uncertainty of knowing which way they’re headed.

 

As Jon Hilsenrath reported in the Wall Street Journal, “She noted there is a wide range of views even among Fed officials about where rates will be by 2016. Fed forecasts range between 0.5% and 4.25%.”2

With more economic expectations, the Fed likely felt secure in continuing its policy of tapering – and it will now reduce its monthly asset purchases by another $10 billion, buying $15 billion in mortgage-backed securities per month and $20 billion in Treasuries.

Yellen remained cautious, declaring that the taper isn’t on any set schedule, except, as the WSJ’s Pedro Nicolaci da Costa, noted “everyone in the market believes it is and that it will likely end in the fourth quarter.”

The only room for doubt, da Costa said, is “whether the Fed will go the full $15 billion in one last go or be more incremental by reducing quantitative easing by $10 billion in October and then $5 billion.”

Market expectations have also appeared to be a boon to stocks that could be expected to benefit from an ongoing Fed tapering. The Fed Tapering motif, which invests in regional bank stocks on the theory that eventually rising long-term interest rates could boost their net interest income and margins, has gained 3% in the past month.

In that same time frame, the S&P 500 is up 2.2%.

In 2014, the Fed Tapering motif has gained 1.2%; the S&P 500 has increased 7.5% this year.

As Hilsenrath explained, the Fed continues to face a dilemma: the five-year recovery has continuously failed to live up to the Fed’s growth forecasts and officials are lowering their expectations of how much the economy can expand in the long run.

Still, he noted, unemployment is coming down faster than expected and inflation shows signs of rising to the Fed’s 2% goal.

As economist Jared Bernstein put it, the Fed is deep into “on-the-one-hand-on-the-other-hand” territory.3 Whichever hand appears to be more relevant over the next couple of quarters could help determine the direction of interest rates, as well as the stocks positioned to benefit from that rise.

1Pedro Nicolaci da Costa, “5 Takeaways from Fed Decision, Yellen News Conference,” WSJ.com, June 18, 2014.

2Jon Hilsenrath, “Fed Keeps Rates Unchanged, Sees Eventual Rise in 2015, 2016,” WSJ.com, June 18, 2014.

3Jared Bernstein, “This is What Happens if You Stare at the Fed’s Dots for Too Long,” June 18, 2014, http://jaredbernsteinblog.com/this-is-what-happens-if-you-stare-at-the-feds-dots-for-too-long/, (accessed June 18, 2014).

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