From the July/August 2013 issue of Futures Magazine • Subscribe!

Fed plants seeds for rational stock and bond markets

Bush also points out that the Fed’s hand was forced by rising bond yields prior to talk of tapering. “U.S. interest rate yields are increasing in spite of the $85 billion in monthly purchases of bonds, so the bond market is saying it does not want to see additional bond purchases. They are not getting what they want from QE.” (See “Bonds started this,” below.)  

While some may argue over the origin of the bond sell-off, everyone agrees equities are following rates. “What is wrong with the equity markets? The answer is the bond market,” Frederick says. “The bond market, from a notional value standpoint, is a whole lot bigger and is a lot more global. With this kind of an interest rate rise since the beginning of May, there is no question that this is a much bigger factor in the equities markets than it normally is.”

Bush also is not convinced that the end of QE3 will bring a return to more rational markets. “When the Fed had their unlimited QE, the bad news on the economy was bullish because it meant they needed more QE; good news was bullish because it meant QE was working. Now it is the opposite, bad news is bad news because QE isn’t working and the good news is [bearish because] they have latitude to scale back.” 

Harold Lavender, a former Chicago Board of Trade director and member of the New Mexico State Investment Council, agrees. “It may be the reverse [of what we have seen], the fundamentals may look better, but the market is not going to go higher.”

Buckley says, “I told my traders there were three taper scenarios: The good, the bad and the ugly: The good was the Fed is getting out of the way because the economy is great and it is a smooth baton hand off, that didn’t happen; the ugly was the Fed just would leave because they are creeped out about what they’re doing; the bad — which is what we got — we are kind of creeped out about what we are doing and the economy is kind of good. Of the three, we got the worst choice.”

Wilkinson, however, expects volatility to curtail if the Fed remains firm. “Fed speakers will continue to deliver the Fed’s message until the child stops throwing the rattle out of the crib,” Wilkinson says. 

“At some point, and I don’t know when this will be, stock prices will divorce themselves from rising bond yields and at the same time bond yields will stop rising so aggressively. My underpinning argument there is the absolute lack of inflation. I still think that despite Bernanke’s discussion of easing off on the bond purchases, we are an awful[ly] long way away from the time that official interest rates go up. So a lot of the fear in the market at the moment is likely to calm over [the] coming weeks and months.”

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