September 19, 2013 | By Scott Minerd
Yesterday’s message from the Federal Reserve was both a surprise to the markets and contradictory. Fed Chairman Ben Bernanke made clear that the central bank’s primary monetary policy tool is forward guidance. However, in choosing not to taper the asset purchase program despite previous indications of an eventual reduction, the Fed raised questions about the credibility of forward guidance. This action will likely have two outcomes for markets. The first we saw begin immediately following the announcement – and that is that interest rates moved materially lower and could continue to do so. The other is that volatility will escalate because market participants will continue positioning portfolios based on what the Fed says can be expected, but will also be forced to try to guess whether the Fed will alter its course depending on the economic data. Yesterday’s announcement of ongoing accommodation was positive in the short-run for stocks, but I believe it will prove to be better for bond investors over a longer time horizon. The Fed opted not to taper because the economic outlook is weakening, particularly in housing. The Fed also reflected this view by lowering its economic forecasts. The result of lower growth will likely be reduced corporate earnings and thus, lower share prices. Lower growth will also keep downward pressure on interest rates, which is constructive for fixed income. It is my view that the yield on the 10-year Treasury bond could ratchet back down to or below 2 percent before this rally is over.
Since the U.S. Federal Reserve first began to release economic projections three years ago, it has consistently downgraded its outlook. In the latest Federal Open Market Committee meeting, the Fed further lowered its projections for GDP growth in 2013 to an average of 2.15 percent, compared with an average of 4.15 percent from its initial projections in January 2011. Despite a steady decline in the unemployment rate, the continuing downgrades of the growth outlook demonstrates that the Fed has been overly optimistic about the underlying strength of the U.S. economy, which supports the decision to delay the tapering of quantitative easing.
Source: Federal Reserve, Guggenheim Investments. Data as of 9/19/2013. *Note: The projection range is the central tendency of the FOMC’s economic forecast, and middle-points of the range are the average of the central tendency projections.
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