Will the Fed Flex More Monetary Muscle? 

Kristina Hooper 

The Upshot 

5/6/2013 

It appears there has been a reversal of sentiment among central bankers on how much stimulus to pump in to the economy. But stocks are rallying regardless of whether conditions require the Fed to step in or not, writes Kristina Hooper.
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Kristina Hooper, CFP®, CAIA, 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.

Central bankers may have to ratchet up the amount of stimulus needed to keep the US economy's engine running. The latest comments from the Federal Open Market Committee reveal a shift in sentiment on the Fed's bond-buying efforts. In March, there was concern about too much stimulus. Now, it might not be enough.

Whether the Fed is injecting sufficient liquidity is up for debate, but the stock market has been treating central-bank intervention as a buy signal. Then again, it's also had the same response to improving economic conditions. And last week was no different. It was a good week for stocks. Most notable was the record set by the S&P 500, rising more than 2% to finish the week above 1600 for the first time ever. Other indices also participated in the rally: the Nasdaq Composite gained more than 3%, the Russell 2000 gained more than 2% and the Dow rose more than 1.75%. In addition, gold inched up slightly while crude oil saw a solid increase in price.

It appears that stocks are benefiting from both negative and positive economic data. That's because the slew of not-so-positive data we've seen since the FOMC met in March helped change the Fed's tone at its meeting last week. The March statement revealed a Fed that was seeing "a return to moderate economic growth following a pause late last year." However, while the latest statement shows recognition that the economy is still recovering, there are concerns that "fiscal policy is restraining economic growth." What's more, it seems the focus at the March meeting was on not pumping too much stimulus into a recovering economy, while the concern this time seems to be about not being supportive enough.

Don't Fight the Fed


More or Less?

More specifically, the March FOMC minutes revealed calls for reducing the number of asset purchases as labor-market conditions improve. FOMC members cited concerns about the possible negative implications of the asset-purchase plan including instability in the financial system, a sudden rise in interest rates and a sudden increase in inflation. But now, it appears that the Fed is worried about being accommodative enough, indicating that it's prepared to purchase more than $85 billion a month in assets as needed based on labor-market and inflation conditions. What a difference a few bad data points can make.

Still, the week finished on a high note as investors cheered a string of positive economic data. The Department of Labor released its April employment report, which showed substantial improvement in the labor market from the lull in March. The unemployment rate fell to 7.5%, showing progress toward the Fed's under 6.5% target. And non-farm payrolls rose 165,000, tepid but better than expected. In addition, payrolls for January and February were revised upward (both months together totaled 114,000 new jobs.)

Laboring Through

However, the jobs recovery continues to be very flawed. For example, job creation was sparse: Growth came from the service sector while the manufacturing industry and the public sector saw a decline in the number of jobs. And while the percentage of those unemployed over 27 weeks decreased in April, it remains high at 37.4% of total unemployed. In addition, the number of hours worked per week fell for the month.

Last week's FOMC statement also indicates some concern about the pace of inflation: "Inflation has been running somewhat below the Committee's longer-run objective." The Fed may be beginning to worry about deflation, especially given that the velocity of money is low and the most recent Chicago PMI report showed that inflation has almost vanished. After all, many critics of asset-purchase programs point to Japan, which embarked on quantitative easing long before many other developed nations' central banks, as proof that it leads to deflation rather than economic growth and inflation. While there are several counter-arguments, the Fed may want to stifle criticism by ensuring that the economy does not get any closer to deflation, and that would mean erring on the side of more asset purchases rather than less.

Recall that the unconventional monetary policy we're seeing—financial repression—puts us in uncharted territory. Look for central banks of many developed countries to re-write monetary policy history.

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The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

 
Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.


A Word About Risk
: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.
 
The Standard & Poor’s 500 Composite Index (S&P 500) is an unmanaged index that is generally representative of the U.S. stock market.

The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 actively traded blue chip stocks, primarily industrials, but including financials and other service-oriented companies. The components, which change from time to time, represent between 15% and 20% of the market value of NYSE stocks.

The NASDAQ-100 Index includes 100 of the largest domestic and international non-financial securities listed on The NASDAQ Stock Market based on market capitalization. The Index reflects companies across major industry groups including computer hardware and software, telecommunications, retail/wholesale trade and biotechnology. It does not contain securities of financial companies including investment companies.

The Russell 2000 Index is an unmanaged index that consists of the 2,000 smallest companies in the Russell 3000 Index and represents approximately 10% of the total market capitalization of the Russell 3000. It is generally considered representative of the small-cap market.

Allianz Global Investors Distributors LLC, 1633 Broadway, New York NY, 10019-7585, us.allianzgi.com, 1-800-926-4456.

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