Your Fed Decoder Ring
My wife Carole grew up in South Dakota and as such, she’s prone to the regional vernacular. Over the years, I’ve learned to interpret what she’s saying. If she tells me in a flat voice that something is “interesting,” that means she really hates it. “Jeet” means: Did you eat? And so on.
Just as I’ve learned to interpret Midwest-speak, investors need to interpret Fed-speak. Brace yourself for a lot of cryptic statements from the Federal Reserve’s annual Jackson Hole (Wyoming) Symposium, Thursday through Saturday. Below, I provide context. Think of this article as your “Fed decoder ring.”
In the meantime, investors are optimistic but wary about the Fed’s next move. On Wednesday, the Dow Jones Industrial Average gained 39.24 points (+0.11%), the S&P 500 rose 9.96 points (+0.22%), and the tech-oriented NASDAQ climbed 22.06 points (+0.15%). The small-cap Russell 2000 gained 8.36 points (+0.37%). The S&P 500 and NASDAQ closed at record highs, for the second consecutive day.
In pre-market futures trading Thursday, the major indices were mixed as stocks took a breather from their record run.
Yeah, I’m goin’ to Jackson…
As the Federal Reserve’s Jackson Hole Symposium gets underway Thursday, Wall Street expects Fed Chair Jerome Powell to strike a balance between emphasizing the U.S. economic recovery and the obstacles ahead (e.g., inflation and the COVID Delta variant). The Fed doesn’t want to be complacent about inflation, but the central bank also wants to avoid premature hawkishness that could undermine the recovery.
Powell is scheduled to make public remarks on Friday. Don’t expect clarity. His oblique utterances will be parsed for sub-texts.
The Jackson Hole confab will be a pivotal event for the financial markets, including the U.S. dollar. Minutes released August 18 of the July 27-28 meeting of the Fed’s policy-making Federal Open Market Committee (FOMC) show that FOMC members behind closed doors are disagreeing about the future of the Fed’s quantitative easing (QE) program, with the usual split between hawks and doves as to whether it’s prudent to start reducing (i.e., tapering) the Fed’s asset purchases.
The Fed’s purchases under QE reduces the available supply of bonds on the open market, resulting in higher prices and lower yields.
Lower yields (i.e., lower long-term interest rates) reduce the cost of borrowing, which stimulates the economy.
The Fed’s balance sheet currently exceeds $8.3 trillion (see chart, with data from August 18, 2016 to August 18, 2021):
QE policies lower the interest rate, so when the purchasing program is reduced, interest rates rise again.
When interest rates rise, it tends to make the U.S. dollar stronger. The higher yields attract investment capital from investors abroad seeking higher returns on bonds and interest-rate products.
Since the end of May, the ICE U.S. Dollar Index (DXY) has been rising. The DXY (known colloquially as “the Dixie”) trades in the futures market on the Intercontinental Exchange (ICE) and the over-the-counter market among foreign exchange dealers. The DXY reflects dollar strength or weakness and is a pricing yardstick for many commodities. The DXY is a measure of the dollar against a basket of six major rival currencies.
Fears that COVID Delta might impede economic growth have boosted the greenback, because of its safe-haven status. Despite low interest rates, the U.S. dollar continues to gain, which underscores the notion that investors view the U.S. economy as a more desirable alternative compared to other national economies.
Tapering should not be confused with tightening. The Fed tightens monetary policy by hiking short-term interest rates through policy changes to the discount rate, aka the federal funds rate. Tapering reflects the gradual retreat from one aspect of dovish monetary policy (to wit, QE), whereas tightening signals the execution of contractionary monetary policy.
The Fed has emphasized that tapering will precede any increase in short-term interest rates. Rates aren’t likely to get raised until 2023, so investors should restrain their anxieties about Jackson Hole.
Tapering is the initial step in the process of either winding down (or ending altogether) a monetary stimulus program that’s already underway.
If “taper talk” this week in Jackson Hole strongly suggests imminent unwinding, it’s hard to predict how stock markets and currencies will react. It will depend on the nuances of the announcements. Tapering will happen; it’s only a question of when.
The resulting uncertainty about these issues has caused markets around the world to be volatile in recent weeks. Will this volatility stick with us for a while, even when the meeting in Jackson Hole is over? As my Midwestern wife would say: You betcha.
The folly of market timing…
Now that the Fed is deliberating about how to taper its stimulus program, investors are focusing on what investments will be affected as a result of the cutback. Regardless, I don’t recommend timing the market in anticipation of any Fed scenario. Market timing based on news events is a fool’s game and deleterious to long-term wealth-building.
Investors who purge their portfolios of, say, utilities stocks with the hope of enjoying greater safety and yield from Treasury bonds may do irreparable harm to their holdings.
The rational strategy is to select investments with strong underlying fundamentals, regardless of shifts in government policy. In fact, we’ve just pinpointed a growth stock that belongs in any portfolio.
This firm is the world’s only producer of a rare, miracle material that’s essential for biological medicine, the Internet of Things, aeronautics, autonomous vehicles, microchips, 5G telecommunications…you name it.
The time to invest in this company is now, before it starts getting widespread coverage by the financial media and its share price soars. Click here for details.