This week the Federal Reserve will be holding their meeting on interest rates. While the Fed sets what’s known as the “federal funds rate” directly, most people will be focused this time around on whether or not the Fed will continue with its current program of quantitative easing. Quantitative easing, or QE, is a term used to describe their action of buying bonds from banks and other institutional investors.
The Fed is currently on their third round of QE. In the first round, they bought mortgage backed securities from banks. In the second round they started buying US treasury bonds. Both the first and second rounds had a set ending point to the program. This round is open ended and theoretically could last forever.
Chairman Ben Bernanke has stated that they will continue or taper the program based on underlying economic data. The mandate of the Federal Reserve is to provide full employment and price stability, so they’ll be focused on the unemployment rate and inflation numbers like the PPI and CPI to determine whether they continue or end the bond buying.
The fact that they’ll continue if the data is weak and taper if the data is strong has brought up an interesting conundrum for market followers, where bad news is good news to some extent and good news is bad news. If we see good job creation with low inflation, which should be good for the market it may mean that they’ll taper the QE. If we continue to see slow growth and tame inflation, the QE should continue.
There’s been a lot of talk in the press lately about fed tapering and what the effect may be on the stock market. There are also many different opinions out there about the effectiveness of QE and about whether or not the fed can stop without crashing the market.
This month’s meeting will be watched very closely for indications of what the Fed’s next step is. One thing that QE has a direct effect on is interest rates. Interest rates have risen from their 200 year lows here over the last month. Rising interest rates impact stocks as competing investments have better yields and also impact the housing market since most home buyers finance their home purchase rather than paying cash.
This week’s FOMC meeting is going to be closely watched by market observers for any signs of what the Fed is planning to with the QE program.
Kenneth Roberts is a Truckee based Registered Investment Advisor. Information on his money management service can be found at his blog at www.sellacalloption.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.