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Fed's Latest Taper Stokes Rate-Hike Talk

21 March 2014 in Trading Ideas

Janet Yellen’s debut at her first Federal Reserve meeting since she was named chairman certainly did not go quiet into the night.

While investors saw another $10 billion pullback (to $55 billion) in its bond-buying program, it was the Fed chief’s apparent signals about how quickly interest-rate increases might follow the end of bond buying that made a mark on Treasury bonds on Wednesday.1

The Wall Street Journal reported that, even though the Fed plans to keep short-term rates into zero next year, investors were concerned that rate increases might come a bit sooner and be more aggressive than previously thought.

The result was a hit to stock prices on Wednesday along with a rise in longer-term rates on Treasury bonds.

Chief among the Yellen’s anxiety-inducing comments, the Journal said, was her suggestion that interest-rate increases might come about six months after the bond-buying program ends – a conclusion that could come this fall.

 

As the Journal pointed out, that projection came with many caveats, but that didn’t stop many investors from seeing the comments as a signal.

The development adds yet another data point of the market’s sensitivity to the Fed’s interest-rate decisions after seven years of aggressive central-bank action to stabilize the economy. The Fed seeks to gradually step back from its easy-money stance as the economy gets on a stronger footing.

On the other hand, the Journal noted, if it moves too quickly it could undercut the very recovery it’s trying to support.

For its part, the Fed took several steps to assure investors that interest rates won’t rise soon and that when rates do start rising the increases will be gradual and limited. For example, the Fed’s official policy statement included a new line noting that officials expect to keep rates lower than normal even after inflation and employment return to their longer-run trends, the Journal said.

However, other investors and analysts pointed to other signs of the Fed’s changing expectations of slightly more aggressive interest-rate increases than it was a few months ago. For instance, the Journal reported, as a supplement to its official policy statement, the Fed released a new median projection for short-term rates at the end of 2015—meaning half of projections were above and half were below—of 1%. That is a small increase from a 0.75% median estimate in December. The median for 2016 moved from 1.75% to 2.25%.

Of course, even though stock and bond markets were rattled after Yellen’s comments, it’s also worth noting that the broader stock market’s run to all-time highs has come at a time when interest rates, while still not incredibly high, have risen above historically low levels that ended early last year.

It’s also true that specific stocks and sectors seemed to have benefited from the expectations of rising rates. The Fed Tapering motif has gained 7.6% in the past month. During that same time, the S&P 500 has increased 1.3%.

In the past 12 months, the motif is up 29.6%; the S&P 500 has risen 21.9%.

As if Yellen’s comments aren’t watched closely enough, any further signal during the bond-buying taper that rate hikes are imminent could be a boon to stocks expected to rise under a higher-rate era.

1Jon Hilsenrath and Victoria McGrane, “Yellen Debut Rattles Markets,” WSJ.com, March 19, 2014.

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