The Fed’s Grip on the Current Market

We saw a rollercoaster ride in the markets for the week ending 6/7, led in large part by reactions to what the Fed is, or what the Fed is perceived to be doing next with their quantitative easing policy.  With each new economic data report, employment report, and statement from the Fed, the markets are reacting to what they believe is the next plan of action from Ben Bernanke and his team.

The Federal Reserve has a dual mandate, which is an aim to keep both inflation and unemployment low.  In its quest to fulfill these two roles, the Fed implemented an $85 billion-a-month stimulus program geared towards buying back US treasuries and mortgage backed securities.  Just this week we heard from Fed officials that they may pull back on this figure in coming months, which in turn sent stocks tumbling.  The fear of a roll back from the Fed is that it would lower demand in these markets thereby creating lower prices and higher interest rates. Already we have seen 10-year treasury rates rise to over 2% along with 30-year mortgage rates rising to a 14-month high of 3.91%, from only 3.35% in early May.  This is a significant increase in only five weeks, and as a result we have seen yield producing securities such as REITs lose value during this period.  The worry is that we could see a slowdown in the housing recovery which has been a driving force in the US economic recovery.

Then along came Friday’s jobs report.  It was neither too strong nor too weak, which sent the markets way up.  If the employment numbers came out too strong they had the potential to continue the week’s downward trend based on fears that the Fed may really begin to roll back their monthly $85 billion stimulus program.  On the flip side, if the numbers were too low, it would prove that the economy isn’t recovering at a strong enough pace, which in turn could send the markets tumbling again.  Instead, we had a number right in the middle with 175,000 jobs added in May, leading investors to believe that the economy is indeed still growing, but not too rapidly for the Fed to stop the stimulus any time soon.

We will continue to closely monitor the Fed and how they plan on dealing with their monetary policy.  Even though they still believe inflation is not an issue, we all know from going to the grocery store and filling our cars with gas on a weekly basis that inflation is real and it is effecting millions of Americans.  We also are aware that the US economy is growing, albeit at a slower pace then the Fed would desire.  This may be a good time to pull some risk off the table in a portfolio, as we’ve started to do, but we are not overly concerned about the continuation of the economic recovery at this point.  The Fed’s decisions have a strong grip over the current market performance as we have all seen in the past week, but economic indicators are still strong and the U.S. equity fundamentals are showing that stocks continue to be reasonably priced.  It is important to stay diversified and manage the upcoming risks of any Fed action accordingly.