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Wall Street braces for Fed's tapering

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Wall Street can’t figure out what markets will do when the Federal Reserve Board begins to wind down its third round of quantitative easing, the $85 billion a month bond buying program. Just anticipating the so-called “tapering,” the Fed’s 10-year treasury bond has nearly hit 3%, pushing mortgage interest rates to their highest level in years. When the November’s jobs report showed the nation added 203,000 more non-farm payroll jobs, pushing down the unemployment rate to 7% and the nation’s Gross Domestic Product up to 3.6%, it was just a matter of time before the Fed’s Open Market Committee acted to curb inflation. “The fact the Fed blindsided everyone in September makes it more likely we’ll have a volatile reaction because nobody’s going to have a large bias or position ahead of this,” said Ian Lyngen, senior Treasury strategist at Stamford, Conn.-based CRT Capital.

All expectations focused last September on the Fed starting the process of reducing Treasury purchases. When Fed Chairman Ben S. Bernanke put tapering on hold September 18, Wall Street rallied, pushing the Dow Jones Industrials average to over 15,258. When the DJIA topped 16,000 Nov. 18, markets started getting nervous about expected profit taking or possible correction. Some Wall Street watchers like Yale’s 67-year-old Nobel Prize winning economist Robert Shiller see another “bubble” potentially causing markets to deflate like they did in when they reached its previous peak at 14,164 Oct. 9, 2007. Shiller expressed some worry Dec. 1 about his CAPER [cyclically adjusted price-to-earnings-ratio] hinting at another possible crash. Price-to-earnings-ratios have been a reliable index to rate the real value of Wall Street share prices, recently hitting the record close Nov. 25 at16, 0072.

If Bernanke announces a move to take after Wednesday’s FOMC [Fed Open Market Committee] meeting, Wall Street could convulse violently with a sell-off, driving mortgage interest rates higher. “They’ll hammer the markets. Equities would fare a bit better because they seem to be the belle of the ball over the last year over bonds,” said New York/San Francisco-based BTIG Managing Director Patrick Boyle. When Boyle talks of “hammering” the market, he’s referring to hedge and private equity fund shifting to short selling, potentially triggering a more broad-bases sell-off. Shiller’s CAPER index makes perfect sense when you consider the spectacular rise in equity prices since the DJIA bottomed out at 6,547 March 9, 2009. Bernanke’s monetary policies pushed the Dow up 144% since hitting bottom, one of the great four-year bull markets in U.S. history.

Given the spectacular run-up, it’s reasonable to speculate about when profit-taking seizes markets, shifting private equity and hedge funds to short-selling strategies. While Bernanke considers “tapering” this week, it’s possible he’ll also consider raising the Federal Funds Rate by at least 25-basis points from its current zero-.25% level. That move could further spook markets from profit-taking into a full-on correction, perhaps as much as 20%. “There is definitely a little bit of profit-taking going into next week,” said Boyle, not seeing anything yet to spoil the four-year-old bull run. “This is the first time we’ve seen the market take a little bit of a pullback in a while, and it’s not a bad thing,” referring to today’s inflated share prices. When sell-offs occur, it puts Shiller’s CAPER index back into whack, potentially preventing what the Oct. 13 Nobel Prize winner calls a stock market “bubble.”

Bracing for the inevitable, Wall Street should ride out any minor change in Fed policy, including “tapering” or small upward adjustments to interest rates, by letting major funds pull briefly out of certain positions. If Bernanke decides to give markets an early Christmas gift by not tapering, Wall Street could see a furious year-end rally. “I don’t think the Fed is going to taper this month. I don’t think we’ve seen enough preparation,” said Stephen Stanley, chief economist at Stamford, Conn.-based Pierpoint Securities. Knowing Bernanke’s on his way out Jan. 31, 2014, he’ll probably leave it to 67-year-old incoming Fed Chairman Janet Yellin. When you consider Bernanke’s reputation as Wall Street’s best friend, he’ll probably roll-the-dice one more time and leave QE3 and interest rates alone until Yellin takes over. Last weeks unexpected two-year bipartisan federal budget deal adds to Wall Street’s security.

Given the relatively anemic pre-Christmas retail buying reports, it's unlikely that Bernanke will rock the boat before ending his second term as Fed chairman. During his term, he guided the U.S. economy out of the worst recession since the Great Depression, winning him praise from just about everyone, except a few partisan economists that think the Fed’s policies of low interest rates and bond buying have weakened the economy’s long-term growth. By anyone’s metrics, certainly published government economic data, Bernanke steered the economy to a soft landing following the 2007-08 economic meltdown and now to a strong economic recovery. Watching Wall Street sail, jobs grow, unemployment drop and now the nation’s GDP hit 3.6% are proud moments for the 60-year-old Fed Chairman, who can only head into retirement as one of the nation’s greatest central bankers.

About the Author

John M. Curtis writes politically neutral commentary analyzing spin in national and global news. He’s editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.

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