Markets calm before Federal Reserve

In the biggest non-story of the month is that the stock markets aren’t moving. Normally this would warrant no coverage at all expect for the fact that it’s before the Federal Reserve Board is expected to announce the end of its stimulus actions.

The Wall Street Journal had this story:

If investors are concerned about the imminent end to the Federal Reserve’s monetary stimulus, the markets haven’t noticed.

Despite widespread expectations that the Fed will announce a trimming of a bond-buying program aimed at pushing down interest rates and propping up the economic recovery, fund managers have been in a buying mood lately.

The blue-chip Dow Jones Industrial Average on Tuesday advanced for the 11th time in 14 trading sessions, and U.S. Treasury prices rose for the fifth straight day.

Many investors expect the Fed to decide to cut its $85 billion monthly purchases of bonds by about $10 billion to $15 billion. Markets were roiled in May and June after Fed chief Ben Bernanke said the U.S. central bank would consider reducing purchases in a process dubbed “tapering.”

Some investors dismiss the prospect of much turbulence this time. They say players in stock, bond and commodity markets have had time to prepare for potential Fed action, assuming the Fed acts largely within market expectations, and that a selloff in bonds since Mr. Bernanke’s comments means there is less potential for a large price decline now.

The bond market, however, showed some signs of paying attention, according to a Bloomberg story:

Federal Reserve Chairman Ben S. Bernanke sent bond yields a percentage point higher just by talking about adding stimulus at a slower pace. The rout serves as a warning to monetary policy makers that their exit from record accommodation won’t be easy to control.

The jump in yields has pushed up the cost of mortgages for millions of Americans, curbed demand for homes and prompted thousands of job cuts at Bank of America Corp. and Wells Fargo & Co., all at a time when the Fed’s policies are aimed at creating jobs and supporting housing.

Bernanke has stressed that any reduction in the amount of money the central bank pumps into the financial system each month doesn’t mean policy is getting any more restrictive. That message hasn’t been heeded by bond investors, demonstrating how hard it will be for the Fed to control long-term interest rates as it moves toward tightening, according to Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.

“Getting out of ultra-low interest-rate policy was never going to be easy, and this is a perfect illustration of why,” Crandall said. “It is possible that this will make it even harder because the market will be even more primed to view inflection points as messy and destructive, and therefore a reason to sell early.”

Fed policy makers meeting today and tomorrow will probably lower the monthly pace of bond purchases by $10 billion, to $75 billion, according to the median response of 34 economists in a Bloomberg News survey on Sept. 6. That’s down from expectations of a $20 billion reduction in a July survey.

Reuters added this commentary about analysts’ expectations around what the Fed might do and how the markets might react:

For the Fed, consensus has congealed around a reduction of $10-$15 billion a month with all purchases ending by the middle of next year. Yet even that cautious timetable would be contingent on the economy performing as well as expected.

With such an outcome largely priced in, it could lead Treasuries and the dollar to rally modestly. A slower tapering would tend to benefit bonds and stocks but hurt the dollar.

The bigger reaction would likely come if the Fed pulled back more aggressively, as that would lead market to price in an earlier start to rate rises as well.

That would be especially painful for emerging market countries that rely on foreign capital to fund current account deficits, with India and Indonesia among the most vulnerable.

Still, dealers warned against a hasty reaction as there were so many moving parts in play.

As well as the tapering, the Fed may chose to alter its threshold for tightening, perhaps by lowering the trigger level on unemployment from the current 6.5 percent.

It will also publish its first economic forecasts for 2016 and the stronger the picture the harder it will be to convince markets that any future rise in interest rates will only be slow and measured.

Indeed, the Fed has already had trouble convincing the market that it intends to keep rates near zero out to 2015 no matter how much the economy improves.

After all the ups and downs this year as the markets tried to determine when the Federal Reserve would act, investors seem to have priced in the potential move already. So as this story goes, it’s really a non-story, but the media is required to write something, no matter if the markets are reacting or not.