The Fed Pulls Off the Bandaid By: Gabriel PotterMBA, AIFA® 2013.12.23

Like many financial offices, we have CNBC playing quietly in the background.  At the moment, CNBC news is rotating through 3 basic stories:  holiday shopping, end of year stock market performance and last week’s announcement from the Federal Reserve.  Regarding holiday shopping numbers, we will look forward to the data.  However, we have to comment on the Federal Reserve announcement and the market’s reaction.  Recall late spring 2013 when the Federal Reserve began to prepare the markets for a potential pullback of the Quantitative Easing program: the equity market plummeted and bond yields climbed to multi-year highs.  Remember, no actions – either in terms of interest rates or QE tapering – actually occurred, but the mere suggestion of action changed market expectations sufficiently to damage equity values and bond prices.   The reaction this time was markedly different.  On December 18th, the Fed announced the QE taper will begin in January; specifically, the Fed will pare down $85 billion monthly purchases to $75 billion.

Traditionally, the Fed suggested two implied targets which might end its accommodative policies:  unemployment hitting 6.5% or inflation hitting 2.5%.  Once either of these targets we’re hit, the implication was that the Fed would rapidly pull back on its support for the economy.  Given unemployment’s recent dip to 7%, positive GDP revisions for 3Q, and all-time market highs, many were wondering how long the accommodative policies could last. 

However, the expectations for this traditional framework was changed during the recent Fed announcement.  Inflation has not been a significant factor since the beginning of the crisis and it isn’t expected to become one in the next few years.  However, the Fed suggested there was latitude regarding the 6.5% unemployment target and they might continue easy-money policies “well-past” that target level.   Markets responded to the news with gusto – with the Dow Jones up approximately 300 points, despite the assumed anxiety of the QE taper.

 

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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