The Fed Perturbs the Markets A more positive view of the economy equals a big negative for Wall Street.

1. The Fed Perturbs the Markets
A more positive view of the economy equals a big negative for Wall Street.
Provided by Dana Calcagno-Wilkins
The end is in sight for QE3. On June 19, the Federal Reserve let investors know that “easing
without end” will eventually end, perhaps as early as mid-2014. Wall Street had anticipated
such a signal, but investors still reacted emotionally to the news, with the Dow Jones Industrial
Average ceding all of its May and June gains in less than two market days. (The index fell 206
points on June 19 and 354 points on June 20.) Bears see the air quickly coming out of the rally;
bulls think the rally will pause during the turbulence, then resume.1,2
Good news implied bad news. In its June 19 policy statement, the Fed presented a brighter
economic outlook. It saw unemployment lessening to 6.5-6.8% in 2014. It also envisioned
growth of 3-3.5% for 2014 and possibly as much as 2.6% growth in 2013.1,3
Then came the press conference after the release of that statement, at which Fed Chairman
Ben Bernanke stated that the central bank could scale back its bond buying in late 2013 and
end its current stimulus altogether next year, provided the economy is healthy enough. While
the Fed will keep purchasing $85 billion in bonds per month in the short term and hold interest
rates where they are until the jobless rate hits 6.5%, Wall Street saw a disquieting big picture:
an end to the era of easy money.2,3
The Fed’s announcement hardly came out of left field, but Wall Street reacted as if it did. QE3
could not last forever; a central bank can only practice aggressive easing for so long before
risking damage to an economy, and the timing of the news was pretty much in line with
expectations. Still, the major U.S. and Asian benchmarks dropped around 2% on the first full
market day after the news and the major European markets were down more than 3%. Gold
dropped more than 6% on June 20 to $1,296 an ounce and the 10-year Treasury yield climbed
to 2.42%, with the real yield of the 10-year TIPS up to 0.46% after rising 0.32% in two days.4,5,6
When & how might the Fed taper? In a new Bloomberg survey, 24 of 54 economists (44%)
believe that the Fed will reduce QE3’s scale to $65 billion a month at its September policy
meeting. Alternately, 28% of the economists feel tapering will start in December and 13% think
we won’t see it until 2014. As to when QE3 will end, 44% of the respondents said June 2014.7
The Fed could end up winding down QE3 later than it anticipates. In fact, you could point to
many statistics in this job market that don’t support tapering. Looking at job creation from
December through May, payroll growth has averaged 194,000 jobs a month – not the 200,000+
the federal government would like to see. The labor participation rate (the amount of people

2. employed + the amount of people looking for jobs) is scraping a 29-year low. Inflation is not
only low, so are inflation expectations: the Cleveland Fed is forecasting average consumer
inflation of 1.4% for the next 10 years.8
Who might get hurt the most when interest rates rise? Investment classes across the board
took a hit in the wake of the Fed’s announcement as emotion ruled the markets. Historically,
fears of rising rates and actual rising rates have tended to affect certain sectors and classes of
investments more than others. The utilities and financials sectors have faced headwinds in such
a climate in past decades, and it is well documented that REITs are highly sensitive to changes
in the interest rate environment. The energy sector and foreign stocks have fared better when
rates rise. Still, past performance is no barometer of future results and the markets hardly
move on logic alone.9
Will the bull market stumble? For some long-range perspective, we’ll let Prudential Financial
market strategist Quincy Krosby have the last word. As he told CNBC last week, "We haven't
had a meaningful correction in the market and if this selloff continues…it doesn't mean the
market is going to collapse. It is essentially recalibrating – the road to normal is going to be
filled with detours.”2
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Citations:
1-bloomberg.com/news/2013-06-20/fed-seen-tapering-qe-to-65-billion-at-september-fomc-meeting.html[6/20/13]
2 - cnbc.com/id/100831276 [6/20/13]
3-foxbusiness.com/markets/2013/06/19/wall-street-pummeled-amid-fed-woes/[6/19/13]
4-cnbc.com/id/100831610 [6/20/13]
5-reuters.com/article/2013/06/20/markets-usa-bonds-idUSL2N0EW1AD20130620 [6/20/13]
6-treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=realyield [6/20/13]
7-bloomberg.com/news/2013-06-20/fed-seen-tapering-qe-to-65-billion-at-september-fomc-meeting.html[6/20/13]
8-marketwatch.com/story/7-charts-that-tell-the-fed-not-to-taper-qe3-2013-06-19[6/19/13]
9-cnbc.com/id/100831621 [6/20/13]
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