The Fed's Surprise Decision Shattered The Complacent Consensus

by: Louis Navellier

When the Federal Reserve's Open Market Committee announced "no change" in quantitative easing last Wednesday, many markets melted up - or down. Gold rose $75, and the Dow Jones and S&P 500 reached new all-time highs, while the yield on 10-year Treasury notes dropped 20 basis points and the U.S. dollar tanked. Stocks settled down by Friday, but Wednesday's announcement showed how dominant the Fed's policies have become, and how addicted to easy money most of our markets have become.

The Fed Surprised Nearly Everybody With No "Tapering"

Maybe I can open this week's Marketmail with a little bragging. For several months now, I have been predicting the Fed would not "taper" this month. I've said it would likely keep quantitative easing in force for the rest of 2013. Even though virtually all economists predicted the Fed would announce tapering at last week's meeting of the Federal Open Market Committee (FOMC), I remained a skeptic.

Two weeks ago, I wrote that the "the dismal tone of the overall labor market means that the Fed will likely remain very accommodative in its summary statement, scheduled to be released on September 18." Then again, last week, I said that "current economic statistics are 'mixed' (negative and positive), so the Fed might not want to gamble on prematurely tapering its level of quantitative easing this week."

Sure enough, the Fed announced last Wednesday that it would "await more evidence that progress will be sustained" before adjusting the pace of its asset purchases. The FOMC said any tightening "could slow the pace of improvement in the economy and labor market." Clearly, the Fed was disappointed with the August payroll report, especially the fact that June's and July's payrolls were revised lower by 74,000.

Even more disturbing, the broader household survey reported a shocking 115,000 decline in jobs. In fact, the household survey is reporting over 400,000 fewer jobs this year than the payroll survey, probably because the payroll survey is dominated by part-time jobs and double accounting of temporary jobs.

The other big shocker in the Fed's statement is that it reversed its previous intent to wind down all quantitative easing by mid-2014. That promise was thrown out the window, so it now appears the Fed will keep its money pump going well into 2015. The Fed's sudden "about face" stems from the failure of its own super-optimistic economic forecast last May, when the Fed forecasted 2.3% to 2.8% GDP growth this year. On Wednesday, the Fed lowered its 2013 GDP forecast to only 2% to 2.3%. The Fed also lowered its GDP forecast for 2014 and said it would not increase short-term rates until 2015 or later.

In effect, Fed Chairman Ben Bernanke is passing the baton to his heir apparent, Janet Yellen, saying "it's not my problem anymore….YOU decide what to do next." As a former San Francisco Fed President, Ms. Yellen is a dove who is keenly aware that some of her home district states (i.e., California and Nevada) have serious job problems. This should likely cause the Fed to remain accommodative under her watch.

Some Profitable Repercussions of the Fed's Sudden "About Face"

Nearly all of the major markets made a sharp "U" turn when the Fed made its surprise announcement:

Stocks soared on the Fed's sudden reversal, hitting new all-time highs on Wednesday. That's because low bond rates will provide Corporate America with an extended window to borrow in the bond market at ultra-low rates throughout 2013, 2014, and maybe into 2015. The relentless stock buybacks we have seen this year will likely persist for another 18 to 24 months. As a result, you can expect more announcements of corporate stock buybacks, like Microsoft's $40 billion stock buyback plan, announced last Tuesday.

In addition, the U.S. dollar "cracked" on Wednesday, falling to a 7-month low relative to the euro and Japanese yen. This is a big deal, since a strong U.S. dollar has been hindering corporate profits at large multi-national companies like Caterpillar. If the dollar continues to weaken, this could fuel a boom in corporate earnings, since about 40% of the S&P 500 companies' earnings come from outside the U.S.

A weaker U.S. dollar also caused commodity prices to rise. Crude oil surged on Wednesday, and gold gapped up 4.6% on Thursday, while silver surged by an even more impressive 6.9% at Thursday's opening. As inflation reignites, stocks in commodity-related companies are also likely to firm up.

Also, bond yields declined on Wednesday, while other interest rate-sensitive investments, like high dividend stocks, surged, celebrating the fact that interest rates would remain lower than Wall Street had previously anticipated. Homebuilders, home improvement stores, and other interest rate sensitive stocks also surged on the hope mortgage rates would remain low, sustaining the real estate sales recovery.

Stat of the Week: Inflation is Still Nearly Non-Existent (0.1%)

Last Tuesday, the Labor Department reported that the Consumer Price Index [CPI] rose by only 0.1% in August, in line with economists' consensus estimates. The core CPI, excluding food and energy, also rose 0.1%. In the past 12 months, the CPI has risen just 1.5%, while the core CPI rose 1.8%, which gives the Fed plenty of latitude to continue with its quantitative easing, since inflation has not yet reached 2%.

On Thursday, the National Association of Realtors reported that existing home sales rose 1.7% in August, to a 5.48 million annual pace, significantly higher than economists' consensus estimate of a 5.2 million annual rate. The National Association of Realtors also reported that median home prices in August rose to $212,100, up 14.7% in the past 12 months. The inventory of new homes rose slightly, but remains at a low 4.9-month supply, which should allow continued home price appreciation in the upcoming months.

Also on Thursday, the Philly Fed's manufacturing survey surged to 22.3 in September, up from 9.3 in August, reaching a two-year high. The Philly index for new orders surged to 21.2 in September, up from 5.3 in August, while shipments also rose to an impressive 21.2 in September, up from -0.9 in August.

And finally, on Friday, the Reserve Bank of India surprised economists by raising its key interest rate by 0.25% to 7.75%. India is the first emerging economy to try to strengthen its currency by raising its key interest rates. Most of the carnage in emerging markets this year has been due to weakening currencies, but that trend may have reached its end after the surprise FOMC announcement torpedoed the U.S. dollar.

Disclosure: I am long MSFT, CAT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: Please click here for important disclosures located in the "About" section of the Navellier & Associates profile that accompany this article.