Boatman: When will 'easing' end?
Today, the Fed will issue a statement about its two-day meeting. Stock traders will be busy analyzing every word. The current stock market volatility began May 22 after Ben Bernanke testified before Congress.
He hinted that the Fed could begin to slow its $85 billion-dollar-a-month bond purchase program. These comments triggered a $3 trillion worldwide selloff. The market has feared an end to quantitative easing for some time.
Probably the biggest contributor to the stock market rise has been quantitative easing. This program has had two main prongs: low interest rate and bond purchases. Government bonds are sold at an auction.
This auction works the same way as when a company has many bidders trying to win its business. The more dollars available to purchase the bonds, the lower the yield or interest rate. Other government units or corporations are able to sell their bonds at a lower interest rate because there is a surplus of money available. If the Fed was not buying, the government and private companies would be in competition to attract funds, so they would have to offer higher interest rates. This helps boost a company's profits.
Traders will be looking for clarity from the Fed about how quickly it may act and how far it will pull back. Will it keep interest rates low and stop bond purchases or both? The low interest rates have helped stocks go up in price since people can earn much in interest from banks or bonds. They have been forced to direct their money to more risky equity investments. When interest rates do go up, it will make stocks less attractive and will increase a company's borrowing cost. It is not a matter if easing will end; it is only a question of when.
The Federal Reserve has said that it will watch the unemployment rate and the general condition of the economy. Both are improving rather slowly. The Fed must be careful about inflation. Keeping interest rates too low can spur inflation to increase. The markets are being influenced by the Bank of Japan and European national banks. They are all wrestling with the same issues.
The market is also carefully watching what is happening in Syria. Last week, the president acknowledged that Syria had used weapons of mass destruction on its own people. He had warned that doing so would cross the red line and the U.S. would react. Combined with the unrest in Turkey, oil prices are climbing very fast.
This can have a chilling effect on the economy and inflation. When it costs more to put gas in your car, you have less to spend on other things. Last week, West Texas Crude went to $98 a barrel. It is likely to move over $100. A couple of months ago it was in the $80s.
If inflation starts to heat up, that could force the Federal Reserve's hand to slow quantitative easing. Next week, we will look at how rising interest rates will affect bond prices. Many people use bonds to try to reduce the volatility in their portfolios.
Gary Boatman is a certified financial planner and local businessman who serves as president of the Monessen Chamber of Commerce.