Minutes released from the Fed's Open Market Committee (FOMC) meeting on May 1, increased concerns that their large scale asset purchase program, known as quantitative easing, may soon taper off and come to a close. This sent interest rates higher and stock markets lower, in what's been called the "taper-tantrum." Many of the markets we follow produced negative results for the month of May.
- The MSCI World Index, a broad measure of developed world's stock markets, declined 0.29 percent.
- The S&P 500, a measure of large U.S. companies, rose 2.08 percent.
- The MSCI Emerging Market Index, a broad measure of the emerging world's stock markets, declined 2.94 percent.
- The S&P REIT Index declined 6.19 percent.
- Gold declined 6.02 percent during the month.
The aptly-named "taper-tantrum" highlights the market's misinterpretation of the FOMC's releases. We believe it is too early to handicap the Federal Reserve's exit and eventual tightening of policy. We think it's crucial to keep the following in mind:
- The Fed's stated targets should be taken at face value.
- The Fed believes that communication of its intention is a policy tool in its own right.
- Inflation is a problem the Fed feels confident it can address, but deflation isn't.
- The Fed's departure from the market is a good thing, so long as it isn't premature.
The FOMC's stated goals are "maximum employment, stable prices, and moderate long-term interest rates"; these targets are based on the unemployment rate and inflation rate, not on purchase amounts or program lengths. The unemployment rate, while declining, still remains above the Fed's stated target of 6.5 percent and inflation remains well below the Fed's target. Based on these targets, and the Fed's increased transparency and open communication, we take the Fed at face value that they aren't planning a major policy shift in the near future. Paradoxically, though the Fed has tried to be as open as possible, the markets seem braced for an unannounced big move and are using the Fed's own information flow to justify the additional anxiety.
When faced with divergent paths, people tend to consider the consequences of each. The two ends of the Fed's dilemma are to either do too little or do too much. The latter will likely result in inflation surpassing the Fed's target – a problem they know how and have the tools to address. On the other hand, we may see deflation if too little is done. Japan showed us that this is not easily addressed, especially when central banks have fewer tools available to address it. When applying this framework, we believe the Fed will err on the side of doing too much. This is not a bad thing. The eventual withdraw of Fed support will indicate a very real vote of confidence that the economic recovery is self-sustaining.
Until we see signs that the Fed's exit is nigh, we are likely to hear about growth scares and periodic market hiccups here at home and abroad throughout the summer; however, the opportunities and outlook here are bright
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