The September Market Commentary was delayed by a week so that we could provide you with our comments about the important events that took place last week; specifically, Larry Summers removed himself from contention to be the next Federal Reserve Chairman at the beginning of the week, and the Federal Reserve released notes last Wednesday from their recent meeting. Below is a summary in plain-English of what the Federal Reserve (Fed) said in the September Federal Open Market Committee (FOMC) meeting, as well as our thoughts on what this all means for the markets moving forward.
Within minutes of the FOMC minutes being released last week, just about every investment asset class surged higher. The big news in the minutes was that the Fed decided not to begin tapering its $85 billion per month bond purchases. For the most part, the news of no taper took the markets by surprise. Consider that not only a few months ago Fed Chairman Bernanke said that it would be “…appropriate to moderate the monthly pace of purchases later this year and continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year.”
One of the ‘tools’ that the Fed claims to have is communication of its thinking and intentions; hence, the statement from above. An important part of communication as a tool is the reliability and clarity of such communication. The statement above, from a few months ago, in comparison to last week’s course reversal has left market observers and participants scratching their head. As many of our parents have told us, actions speak louder than words. According to data compiled by Bloomberg, since QE3 started in January, the Fed has been increasing its balance sheet at a pace above the $85 billion per month, with the highest month of purchases in April at $114 billion. Logic would dictate that if the Fed is buying more than the ‘communicated’ $85 billion monthly, then the economic weakness must warrant overshooting its commitment. Again, actions are saying something different than the ‘communication’ from the Fed. This begs the question of whether the market will place less credibility in the Fed’s communication going forward?
After each release from the FOMC, Bernanke holds a news conference where a statement is read, followed by a Q&A with the media. At the heart of the recent statement, and much of the Q&A, was that the taper was pulled off the table as a result of weaker economic data. Specifically, Chairman Bernanke identified “tighter financial conditions”(i.e., higher interest rates) as the reason for not tapering. According to the Fed, a decision to taper, as well as to raise interest rates eventually, will be dependent on economic data. In the course of the Q&A, a question was asked about financial conditions in the economy and interest rates. In Bernanke’s response, he stated that “…interest rates in the US, as well as other countries, have risen as a result of better economic data.”
If we are to understand this correctly, the economy is not strong enough to reduce the over-inflated bond purchases, yet it is strong enough to move interest rates by the largest percentage move in 50 years. If the economy is so strong, then why did all but one of the 12 Fed governors vote to continue bond purchases at their current pace? Something is not squaring here. We have been told that the US economy has been out of recession since 2009. In addition, we have been at zero interest rates since 2008 with the Fed buying unfathomable amounts of bonds in an effort to control interest rates. The Fed has insisted that it can layoff the bond purchases without disrupting the economy. However, the recent move on the 10-year US Treasury bond yield to near 3% (which is well below historical norms) has caused the Fed to continue its bond purchases. Keep in mind that the recent move in interest rates came as a result of the Fed saying they would be lowering bond purchases. It may be that the Fed is trapped in buying bonds lest the economy be negatively impacted by a normalization of interest rates.
The scuttlebutt surrounding the Fed’s decision not to taper is that with the withdrawal of Larry Summers as a candidate for the next Fed Chair, it leaves current Fed Vice-Chair, Janet Yellen, as a shoe-in for the job. As such, many think the decision not to taper was driven by Ms. Yellen since she has been a major contributor to the crafting of the QE programs. If this is true, it would be no surprise since Ms. Yellen is on the record as being in favor of negative interest rates and ultra-loose monetary policy.
As always, we will continue to watch the economic data and actions by global central banks to address the risks that come with trying to unwind the unprecedented economic actions taken thus far.
Do you have an investment strategy that seeks to protect your portfolio against volatile economic conditions? Call me to schedule a free review of your current investment portfolio – 913.402.6099.
John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals. For more information, visit http://www.chladekwealth.com.