Finally, the long-awaited tapering announcement: The US Federal Reserve announced "no taper" for now.
Bond prices immediately rose along with stock prices in the wake of the surprise announcement.
Tapering: What is it? Tapering is the gradual withdrawal of the US central bank's quantitative easing (QE) program. It is not the same as "tightening.”
What is quantitative easing, and why is it important? Quantitative easing is the term applied to the Fed’s program of buying various bonds in the open market. Its purpose was to inject the central bank into the process of setting long-term borrowing rates, i.e., pushing those rates downward. Borrowing rates for residential mortgages and US corporations, and interest rates on Treasury yields, have probably been substantially lower than they would have been had the Fed not implemented QE.
Did it work? Many believe that the program did not achieve the publicly stated goal of achieving better job growth, but many think QE allowed the economy to avoid a worse crisis.
Why did the Fed do this? The Fed decided not to taper because it believed that it was not meeting the second of its two objectives, 1) low inflation and 2) job growth. Unemployment has tracked above 7% all through the expansion that began at the end of the recession in July 2009, signaling to the Fed that it has fallen short on job growth. The Fed wants to see unemployment rates below 7%.
What do we think?
For bond investors: We think that this announcement means that tapering will still occur, but not for a while. Rising rates will come, eventually. The economy is still growing. The business cycle has sustainable drivers behind it. In this case, we expect that a temporary rise in bond prices in the wake of the announcement gives bond investors a chance to tilt their portfolios a bit more toward credit and away from pure interest rate risk (AAA bonds). And it gives them a breather, allowing them the time to implement a plan to shorten the length of the average maturity of their fixed-income portfolios.
For stock investors: This is a boost for short-term stock prices. But concerns will arise that the Fed is worried about slower growth ahead, and these concerns could be a negative for the stock market. We see continued strength in the business cycle and believe higher rates are the likely outcome for investors. History tells us that higher rates are associated with better corporate earnings and corporate health, and the stock market is likely to continue its path upward despite the rise in rates, reflecting optimism over growth rather than fear over high rates.
Summing it up
For bond addicts: The “no tapering” announcement is not a reason to be euphoric. Even though bond prices rose, price erosion may lie ahead. But the news is a gift for investors who, in light of world growth, procrastinated in re-examining their bond portfolios. The question now becomes: What changes can be made to bond portfolios now that prices have suddenly risen?
For stock buyers: The stock market will worry about long-term growth, but it sees the Fed's announcement as a near-term positive in that it believes it will continue to be supported by keeping interest rates in check and the system liquid, at least for a while. Despite the Fed’s concerns about growth and jobs, the cycle is supported by manufacturing, rising work weeks and better auto and house sales.
No forecasts can be guaranteed.
The views expressed are those of James Swanson and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation or solicitation or as investment advice from the Advisor.