Kristina Hooper, CFP®, CIMA®, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
What a difference a few minutes make.
Stocks started the year with a six-week winning streak as economic conditions continued to improve and central bankers maintained an accommodative monetary policy. But investors were briefly shaken by last week’s release of the minutes from the January Federal Open Market Committee meeting. In fact, the stock market sold off significantly on Wednesday; while it had recovered by the end of the week, the rebound wasn’t enough to prevent the first weekly drop for the S&P 500 in 2013.
The minutes frightened investors because they indicated that FOMC members had an in-depth discussion about the continuation of the asset-purchase program, as there seemed to be more concern than ever before about further bond buying. Some members expressed concern about the possibility of inflation over the medium- and longer-term. Others feared that the Fed’s policies may foster risk-taking behavior that could ultimately undermine financial stability. In addition, there was concern that the Fed could be exposed to significant capital losses when its large portfolio of long-duration assets is unwound. And some committee members worried about the potential risks of further asset purchases on the functioning of the financial markets, although others noted that there had been little evidence to date of such effects.
There seems to be resolve among the FOMC members to monitor the asset-purchase program more closely, which, in turn, means they are closer to acting on their concerns. One FOMC member argued that the level of asset purchases needs to be adjusted after each committee meeting, depending upon the data. Bottom line: the asset-purchase program is likely to receive greater scrutiny going forward and runs the risk of either being altered or stopped in the near term.
This sentiment rippled through the stock market last week. An end to or modification of the purchase program in the short term means we would lose one of the few tools—and arguably the most effective tool—the Fed has at its disposal. That’s because the Fed has not just been embarking on quantitative easing, but also “qualitative easing.” Qualitative easing is a term coined by Willem Buiter, a professor at the London School of Economics, to describe an asset-purchase program that involves a diversification into riskier and less liquid assets. It’s through the Fed’s qualitative and quantitative easing that we have seen long rates fall and more liquidity in the mortgage market, both of which have supported housing and the consumer. In fact, some market observers attribute the Fed’s success with its quantitative-easing program relative to the Bank of Japan to its use of qualitative easing at the same time.
We know that the consumer represents more than two-thirds of GDP and that research shows housing generally has a greater impact on consumers’ perceived wealth than the stock market. Therefore, it stands to reason that investors would be shaken, at least temporarily, by the threat of a pullback in asset purchases while the economy still seems fragile.
The Bigger Picture
Still, something bigger may be at stake here, resulting in such a significant market reaction: fear that the Fed may limit its role in supporting and growing the economy. Consider the headline in this weekend’s Wall Street Journal entitled “Japan Seeks Ticket to Growth from New Central-Bank Chief.” Or that last year it took European Central Bank President Mario Draghi’s pledge that the ECB would embark on an unlimited bond-buying program in order to support euro-zone stocks and dispel concerns about a Eurozone breakup. All around the world, fiscally-challenged countries are looking to central banks to be the economic stimulators of last resort. And most central banks have delivered on that expectation, purchasing assets and injecting liquidity into their economies. However, the need clearly remains and any sense that a central bank such as the Fed is abdicating this role is a cause for a crisis in confidence.
But investors should not despair. Don't forget that Fed Chairman Ben Bernanke and Vice Chair Janet Yellen are still very much in favor of further asset purchases. So it seems unlikely that the Fed will stop its asset-purchase program entirely any time soon, especially with unemployment at 7.9% and economic growth still very sluggish. After all, it seems investors won’t allow the Fed to shirk its responsibility as a central bank to be the stimulator of last resort.
Eventually, central bankers will have to pass the baton to businesses and consumers to keep the economy growing. But for now, the Fed is the fuel that makes the markets go.
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