The Fed Had Better Fix This Mess Next Week

Includes: DIA, IYR, QQQ, SPY
by: Markos Kaminis

Securities markets have been in turmoil since May 22nd, when the Federal Reserve released the minutes of its last meeting and Fed Chairman Bernanke testified before the Joint Economic Committee of Congress. Discussion of potential "Fed tapering" away from its asset purchase programs and eventually its interest rate position has caused quite a stir globally. Considering that the economy is still far from healthy, with unemployment grossly underestimated and the real estate recovery vulnerable, I expect the Fed will want to do some backtracking next week. Given the extent of the activity scheduled for it, it will have ample opportunity to dictate its message clearly and concisely this time.

The Federal Open Market Committee (FOMC) begins its two-day monetary policy meeting on Tuesday. On Wednesday at 2:00 PM ET, the Fed will publish its latest monetary policy statement, which can only offer one message (save dissenting votes), unlike the meeting minutes, which showed some debate about when the Fed should take its foot off the economic gas pedal and stop quantitative easing. Fed policy decision making is dynamic but also transparent, leading to market speculation and also to confusion among some in Congress. At his testimony last month, Chairman Bernanke did his best to dissect the connection being made by some Congressmen between each of the asset purchase programs and interest rate policy. He said that no one potential future action meant another would follow, and that economic conditions would dictate each individual move.

This month, the Fed will also be publishing an update to its economic forecasts for GDP, price inflation and employment. I took issue with the Fed's last update, because it seemed to incorporate no accounting for the 1.5% GDP impact this year that Federal Reserve Chairman Bernanke agrees with the Congressional Budget Office (CBO) should come from the payroll tax break expiration and the sequester spending cuts. Given recent signs of deterioration in manufacturing and various other signs of economic illness, like deflation for instance, it will be interesting to see what the Fed forecasts now. I expect a reduction to its GDP growth outlook, down from the 2.3% to 2.8% outlook published in March, which by the way, was down from December's 2.3% to 3.0% forecast.

The impact of any downward adjustment to economic projections, assuming they were not drastic, would easily be mitigated by clear communication from the Fed chief that asset purchase programs, while always under consideration, were not going to end anytime soon.

Market Security

Since May 21, 2013



SPDR Dow Jones Industrials (NYSEARCA:DIA)


PowerShares QQQ (NASDAQ:QQQ)


That should be adequate enough to reverse the spiking trend of interest rates, which began in early May on speculation about future Fed action. The events of May 22nd only confirmed preexisting investment community fear that the economic happy pills it had become so accustomed to might be taken away soon. Thus, I believe that if some facsimile of my dictum is not reflected in the Fed discussion next week, or if it exacerbates concern with more of the same speak, then the Fed could very well derail the real estate recovery. Real estate securities, save homebuilders, have been hard hit since the news broke, with the iShares Dow Jones US Real Estate ETF (NYSEARCA:IYR) down 9.8% since its close on May 21. Higher mortgage rates are impacting mortgage activity, despite the false hope provided to the market by last week's holiday skewed data. Even a diversified lender like Citigroup (NYSE:C), which is supposed to benefit from a rising yield curve, saw its shares down 4.7% since their May 21 close, I believe because of concern about housing.

Believe it or not, my faith in Chairman Bernanke was reinforced by his testimony last month. Given my belief that he is up to the challenge and capable of restoring stability to the financial system, I expect him to use his press conference Wednesday to restore confidence to financial markets. He should indicate that no plans are in the works to reverse Fed policy in the near term. He will also remind the public that eventually appropriate Fed action will accompany relative economic health, but I expect interest rates may finally stabilize or even retrace lower ground on his reassurance. It is not rising interest rates we fear, but spiking rates that are disturbing. Rates should be steadily rising to properly fit with economic activity, not spiking on fear and panic. Hopefully, the Fed will do its part to calm the markets and steady the economy it has worked so hard to sustain.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.