Positive Economic Outlook Initiates Retreat From QE Policy

June
23

Written by: Jon McGraw

It was the comments at the end of this week’s FOMC meeting that overshadowed the meeting itself.  In summary, Ben Bernanke’s announced a more enunciated plan to end the existing Quantitative Easing program.

The Fed’s conclusions are in response to more positive outlooks for the economy and the labor market since the fall. Conditional upon continuing economic progress, reduction of purchases will continue to decrease to zero by midyear 2014. One condition for the ending of purchases would be an unemployment rate of 7%, which would be down 1.1% from the beginning of the QE program. Furthermore, the Fed concluded that it had no intentions of raising the federal fund rate above 0-.25% until the unemployment rate nears 6.5%.

A movement away from the extreme QE policy was expected considering current economic conditions, however both the stock and bond markets sold off on the news. The economy is generally recovering with home and stock prices seeing significant gains in the previous year. Unemployment is down 2.4% from its highest point and is expected to continue to fall. Considering the positive outlook, many believe the extreme QE approach has become unnecessary and unsustainable. J.P. Morgan analysts Dr. David Kelly and Anthony Wile speculate the “recent monetary policy may have been more of a drag to the economy than a boost”, referencing the reduction in savers’ incomes and the discouraging of lending and accessing new credit. Source: J.P. Morgan Market Bulletin June 21, 2013

Regardless of the expectedness or appropriateness of the FOMC’s conclusions, sharp selloffs occurred across both the stock and bond markets. Reactions in the fixed income markets seem justified considering the reports, but in our opinion the stock market reaction seems extreme. A positive economic outlook should increase investor confidence, however it seems some market participants see the QE as a necessary component to economic growth. Regardless, the majority of economic indicators point to positive trends: growing housing and stock markets, falling unemployment rates, and especially the return of interest rates to more “normal levels”.

In brief, our bond portfolios are positioned for a gradual trend higher in interest rates, equity positioning continues to maintain a focus on growth and our alternative positions are in place to provide additional diversification: A hedge against declines in both the stock and bond markets like we saw this last week.