December Fed Tapering

Dear Friends and Valued Clients,

At its eighth and final meeting of the year, the Federal Reserve’s (Fed’s) policy making arm, the Federal Open Market Committee (FOMC), announced that it will be scaling back its bond-buying program known as quantitative easing (QE). This is the beginning of the infamous taper that has garnered so much press this year. Citing less fiscal drag and the “cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions”, the Fed will now buy $75 billion per month in QE – $10 billion less than the current $85 billion monthly.

Ahead of the meeting, most market observers believed there was a slightly lower probability of a December taper than a delay until early 2014. So, in that regard, Wednesday’s action by the Fed was a small surprise. However, the big surprise was the market’s reaction: stocks, as measured by the S&P 500 Index, experienced sharp gains to all-time highs and the bond market movement was relatively muted. This is a far cry from the extreme “taper scare” we experienced during the Spring & Summer that sent stock prices down and bond yields higher with the mere mention of the word “taper”.

There are many reasons why the market reacted so positively to the decision to taper this week:

  • First and foremost, the market was better braced to handle tapering given the continued improvement in the labor market and fewer potential fiscal headwinds caused by Washington, D.C. in 2014. When the market first began to digest tapering back in the Spring & Summer of 2013, the view by many was that “tapering” meant “tightening”. In other words, a taper would be the beginning of the Fed withdrawal of its accommodative policies of keeping interest rates low, boosting the economy and fueling recovery in the job market. However, the Fed was clear in its statement this week that a taper does not equate to tightening and that if the economy weakens (or if inflation does not accelerate) it could do more QE if needed.
  • Secondly, the Fed accompanied its announcement to taper with language promising to keep rates lower for longer. It was this “enhanced guidance” from the Fed that was the real catalyst for the market’s positive reaction. Previously, the Fed had signaled that at an unemployment rate below 6.5%, it would begin to entertain the prospects of removing its “ZIRP” (Zero Interest Rate Policy). However, in this week’s statement, the FOMC altered its time horizon of maintaining exceptionally low interest rates to “well past the time that the unemployment rate declines below 6.5%.”. Therefore, the Fed essentially signaled a path of lower interest rates for longer than previously indicated.
  • Lastly, the market was so fixated on whether the Fed’s actions this week would be hawkish (either through tightening or tapering) or dovish (very accommodative), it missed that the Fed actually had a different “animal” on its mind. Instead of being a hawk or a dove, the Fed’s statement was a bull – as in a very bullish and confident assessment of the economic landscape. The FOMC statement noted the “underlying strength of the broader economy”. This rosy view of the economy provides a much needed boost of confidence for many market participants and investors that the U.S. economy is indeed getting markedly better.

In a sense, the Fed made somewhat of a “trade” with the market. On one side, the Fed reduced QE by $10 billion per month, while on the other side, the Fed delivered a very bullish and confident view on the economy and signaled that it would keep interest rates lower for longer. When the market looks at this “trade”, it sees it as a good one. The market is more than willing to give up $10 billion in purchases now (via the taper) in exchange for a bullishly confident Fed that is likely to keep rates lower for longer. After all, it is the Fed’s Zero Interest Rate Policy, not its soon to be tapered bond purchases, that has the biggest impact on maintaining lower rates and boosting economic growth.

In short, the Fed delivered a holiday surprise for the market – instead of the perceived lump of “taper” coal, the market got a bullish forecast by the Fed via a signal that it will remain “highly accommodative” with low interest rates for a longer period of time. We view Wednesday’s decision by the Fed as reaffirming our overall constructive view on the markets and economy in 2014. We continue to believe that 2014 marks a return to a focus on the fundamentals of investing rather than reading the tea leaves in policy statements or assessing the veracity of politicians’ threats. That is one of the best presents we as investors could receive.

As always, if you have questions, we encourage you to contact us.

Best regards,

As always, we encourage you to contact us with any questions or concerns.

Best regards,
Benchmark Wealth Management

Securities and Advisory Services offered through LPL Financial, a Registered Investment Advisor, member FINRA / SIPC.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All indexes mentioned are unmanaged and cannot be invested into directly.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Stock investing involves risk, including the risk of loss.
Quantitative easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

S&P 500 is an unmanaged index which cannot be invested into directly. Past performance is no guarantee of future results.

This research material has been prepared by LPL Financial.

Tracking Number #1-231769 | Exp. 12/14