Every equity trader’s friend Mr “Helicopter” Ben Bernanke stated yesterday the FED might start cutting on its asset purchasing program this year and eventually end it completely by mid 2014. The Federal Open Market Committee left its pace of monthly asset purchases unchanged at $85 billion as widely expected by investors, but made clear to the market that that tapering is on its agenda, upsetting those who believed QE4EVA. Markets are deep in the red as write and gold is heading for the second mini-crash of the year.
The FED raised its growth forecasts for next year from 2.9% – 3.4% to 3.0% – 3.5% and decreased the expected unemployment level to 6.5% while highlighting that downside risks to the outlook for the US economy and the labour market have diminished.
Although carefully choosing his words and avoiding an explicit statement re the pace for QE tapering, Bernanke stated that “it would be appropriate to moderate the pace of purchases late this year…” as the US economy is improving, adding that any decreases in bond purchases would occur gradually until being extinguished by mid next year. These comments recognize the need to gradually end the current quantitative easing program as the FED balance sheet nears $3.4 trillion. At the same time, why would the FED continue with extreme easing when the US economy is no longer bumping along the bottom? GDP is expected to grow near 2.0% this year while the unemployment rate is currently sitting at 7.6%. Those aren’t the best lof stats but are still much better than they were three years ago.
In terms of interest rates, the central bank continues to keep its Fed funds target near zero and the committee expects it to stay that way through to 2015. Ben Bernanke has made clear that he is much more concerned with deflation than with inflation and with the latest consumer price indicator rising at just a 1.1% pace, there’s no rush to start thinking about a possible interest rate hike.
All this could be good news for the equity market. The FED raises its growth estimates for the US economy, expects good developments in the job market and rising corporate profits and decides to reduce its intervention – a sign that the long crisis is now well and truly over. For gold, not so good news as its appeal as an inflation hedge drastically diminishes with QE tapering. Let’s look at the following table for a variety of market reactions to Bernanke’s words.
US markets are down more than 2% since June 18, the FTSE lhas ost almost 3%, the US dollar is heading north against the Euro, Yen and the Pound by more than 1%, and silver and gold have figuratively hit the ground, dropping 8.4% and 5.7% respectively. At the same time, Treasury yields are heading higher while mortgage rates are at a 14-month high. The US economy is addicted to QE and it won’t be easy for the FED to reduce its drug dose without experiencing major withdrawal symptoms. This is proof that the rise experienced in the stock market has been inflated by the FED rather than being a consequence of an improved economy and as the FED begins tapering, the market will have some serious headwinds.
In our view this is the time to carefully sell some riskier stocks, especially the Nasdaq and tech arena, as they will likely be the most pressured down given the elevated valuations. At the same time, China seems to be cooling adding further to pressure on the global economy. Nevertheless, we still don’t think Bernanke will act drastically and so if the market drops substantially, expect some FED President to appear on TV to make soothing and dovish comments to temper any tapering expectations. The key here is the inflation rate. As long as it stays “under control”, Bernanke won’t mind extending the FED’s balance sheet a little bit more. We think he was largely posturing yesterday and any further rout in the miners and gold and silver is another sterling opportunity to took away these assets.