On Wednesday June 19th, following a regular Federal Reserve Board (Fed) meeting, Chairman Ben Bernanke made an announcement composed essentially of two parts. Mr. Bernanke said the Fed would wind down the bond-buying program, in which they have been buying $85 billion in bonds monthly, and work towards a goal of ceasing the operation by mid-2014. His justification for the change is an optimistic assessment of the current state of the economy and its direction over the next two years. The Fed expects the jobless rate, which was 7.6% in May, to fall to 6.5% to 6.9% by the end of 2014. Mr. Bernanke commented on better fundamentals, saying, “In particular, the housing sector, which has been a drag on growth since the crisis, is now obviously a support to growth.” He was referring to rising home prices increasing household wealth and thereby strengthening consumer confidence and spending. Overall, the Fed expects the economy to grow by 3.0% to 3.5% in 2014, which would be a marked improvement. The Fed also expects inflation to remain low, between 1.5% and 2%. Other members of the Fed indicated that it is unlikely the Fed will begin pushing up short-term interest rates until 2015. Better economic growth, low short-term interest rates and a housing boom all seem very positive. The problem is, many in the financial community believe the result of the Fed reducing, then eliminating the bond program will bring higher mortgage interest rates, a slowdown in housing, reduced consumer confidence and a stalling of the economy. Fear of what might happen when Mr. Bernanke steps down in January of 2014 is an additional negative. Markets don’t like uncertainty!
The bond and stock markets’ response to this change was sudden and sharp! The value of bonds and the value of stocks both dropped. As interest rates on a bond rise, the value of the bond drops. A month ago, for example, the 10-year Treasury bond had about a 1.7% interest rate. Now, the rate is 2.59%, or a drop in value of about 8%. The stock market has also taken a big hit with the S&P 500 down 5.7% since May 28th, falling from 1661 to 1566. Gold, too, has fallen. The day of Bernanke’s announcement, the value of an ounce of gold was $1,373.60 and is now $1,276.90, a drop of over 7% in a matter of days. So much for the safety of gold. For the investor, this may be a good time to take a summer respite and come back in the fall. The next few months could show substantial market volatility. If Mr. Bernanke and the Fed are correct, we should see the economy continue to pick up as we move forward in 2013. That being the case, the stock market should recover, eventually, and the bond market will settle down. For now, we will wait and see.
Ed Mallon
(written Monday, June 24, 2013)
