Miles on Money: The markets and the Fed
Friday, June 28, 2013 7:00 AM
My wife and I are fortunate to own a small farm outside Des Moines that includes a couple of fishing ponds. Over the years, we have experienced the extremes of our state’s weather, but nothing was as distressing as the drought of 2011 and 2012. At one point last winter, our upper pond had fallen nine feet below normal levels, and was only about 60 percent of its normal circumference. The fish had a rough go of it.
As the moisture levels began to return to normal this spring, our lower pond – because of its larger watershed – recovered quickly, and when water began spilling over the overflow, we took the opportunity to provide some “stimulus” to the upper pond. Over a period of about five weeks, we pumped roughly 2 million gallons from the lower pond to the upper pond.
Fortunately, the rains also kept coming, eventually amounting to the wettest spring on record. Thanks to a combination of those rains and our stimulus efforts, about four weeks ago the upper pond reached capacity and we turned off the pump. Today, both ponds are full, and our situation has stabilized.
I tell this story because of all the attention currently being paid to the Federal Reserve’s monthly bond buying program, or “quantitative easing.”
To push long-term interest rates down and stimulate the economic recovery, on and off since November 2008 the Federal Reserve has been buying longer-term bonds. Since September 2012 it has been buying $85 billion a month, and has committed to continue buying at some level until the labor market improves “substantially.” As the unemployment rate has barely budged from September 2012 – declining from 7.8 percent to 7.6 percent – one would not expect the Fed to end its bond buying program just yet. And indeed, it is not. But the Fed is beginning to talk about it – “it” here being first slowing or “tapering”, and then stopping.
But on May 22 during his testimony to the Joint Economic Committee of Congress, when Fed Chairman Ben Bernanke was asked when the Fed might begin to slow (not end) its stimulus efforts, he responded: “We could do it in the next few meetings.” Stock and bond markets both immediately lost ground.
Following its June 19 meeting, the Federal Open Market Committee issued a statement that bond purchases would continue at the $85 billion pace. But when Bernanke commented that tapering could begin later this year and – if the economy continues to grow – the bond buying program could end entirely by the middle of next year, global markets shuddered.
The next day, the yield on the 10-year Treasury, which was 1.62 percent on May 3, rose to over 2.24 percent, and the S&P 500 index fell, reaching a level 4 percent below its May 21 high of 1,669.
All this because we are moving closer – or at least so it appears – to a day that we all knew was coming. After all, much like the small-scale stimulus my wife and I applied to our farm pond, even the most casual market observer had to recognize two things: Quantitative easing was never going to be permanent. And, at some point, long-term interest rates would rise above their artificially depressed levels.
In our view, the hue and cry on Wall Street – particularly in the equity markets – is overdone. On the farm we are fortunate that the fish do not watch CNBC. We could monitor our pond’s water levels and discontinue stimulus efforts when conditions warranted, without concern over “market” reactions. Chairman Bernanke has a much tougher challenge.
We welcome an eventual end to Fed bond purchases as a sign that the economy is moving toward a self-sustaining path and that the era of financial repression will soon end. Fixed income investors have been punished with negative real returns for too long. And if some stock market speculators foolishly relied on “free” money to overvalue their investments, long-term equity participants know that a strengthening economy is a necessary foundation for positive equity returns. We are moving the right direction.
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