After weeks of conjecture about the Fed’s next moves, guess who is in the spotlight this week, ready for his close up? Ben Bernanke and the Federal Reserve Open Market Committee convene a two-day scheduled policy meeting on Tuesday and Wednesday. While there is no expectation of any change to monetary policy (short-term rates should remain at 0-0.25 percent, which is where they have been since December 2008 and the central bank will keep buying $85 billion worth of bonds each month), Fed watchers will parse every word of the accompanying statement; pour over the updated economic forecasts; and listen closely to Bernanke’s subsequent press conference. Investors have been gripped by Fed-fever since Bernanke’s May 22nd testimony on Capitol Hill, when the Chairman had the temerity to suggest that the central bank could taper its bond buying it the economy were to perk up. Suddenly, it was as if every trader feared what the rest of us have craved for over four years: economic improvement!
While there has been progress (jobs, housing, retail sales), chances are that the Fed will not taper until the September or December meetings. Don’t tell that to bond investors, who are trying to get a jump on the Fed by selling in advance of any announcement. And of course they are right: whether its September, December or early next year, the Fed will determine that the economy is strong enough to go it alone, without the central bank’s intervention.
When the government stops buying bonds and eventually starts to sell them, will it be the death-knell of the bond market? According to Capital Economics, the Fed absorbed 38 percent of the treasury bonds issued between the end of last September (when QE3 was launched) and the end of May 2013. When QE1 and QE2 ended, the damage to the bond market was muted, because anxious investors stepped in and filled the void. This time, there is no European debt crisis to create a “flight to quality” nor is there the belief that the Fed will act again. That said, if the rout in emerging stocks and bonds continues, there could be a uptick in foreign demand for US debt.
The whole idea of the Fed shifting gears is a good thing – it means that the economy is strong enough to go it along and frankly, if the economy can’t absorb higher interest rates, we have bigger problems brewing. In a “normal” economy, the benchmark 10-year yield usually runs close to the pace of economic growth. With most projections showing the economy returning to trend growth of 3 to 3.5 percent in 2014 and 2015, it would stand to reason that the 10-year yield would rise.
Some have been suggesting that the economy can already manage higher rates and that the Fed should get out of the way. Scott Minerd, global chief investment officer at Guggenheim Partners recently noted that Fed buying has badly distorted the bond market and that “The yield on 10-year Treasuries would be roughly 150 basis points higher than it is today” without the Fed’s actions.
“Won’t higher rates kill the housing recovery?” You would think the world had ended when 30-year mortgage rates increased from 3.375 percent to 4 percent, you know where rates were way back in 2011 and early 2012. It’s hard to imagine that 4 percent will stymie the housing recovery, though it may slow down the re-fi market, which has dropped by over 35 percent over the past 6 weeks.
Markets: The first three-day losing streak of 2013 came and went and we survived…and really, it wasn’t all that bad because despite falling in three of the last four weeks and losing 2.5 percent from the recent highs, U.S. stocks remain solidly higher on the year.
- DJIA: 15,070, down 1.2% on week, up 15% on year
- S&P 500: 1626, down 1% on week, up 14.1% on year
- NASDAQ: 3423, down 1.3% on week, up 13.4% on year
- July Crude Oil: $97.85, up 1.9% on week
- August Gold: $1387.60, up 0.3% on week
- AAA Nat'l average price for gallon of regular Gas: $3.62
THE WEEK AHEAD:
G-8 Meeting in Northern Ireland
8:30 Empire State Manufacturing
10:00 Housing Market Index
FOMC Meeting begins
8:30 Housing Starts
2:00 FOMC Meeting announcement
2:00 FOMC Forecasts
2:30 Bernanke Press Conference
Euro zone finance ministers meet
8:30 Weekly Claims
10:00 Existing Home Sales
10:00 Philadelphia Fed Survey
10:00 Leading Indicators
Quadruple Witching: When stock index futures, stock index options, stock options and single stock futures all expire. Because investors must close out of their positions, trading volume and volatility can increase on quadruple witching