Fed Watch: What To Expect From The Markets

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Includes: AGG, GLD, SLV, SPY
by: Robert Wagner

I recently wrote an article detailing my expectation for the long-term implementation for the Fed's "taper." My expectation is that the taper will be long, slow, uneven and gradual because fiscal policy simply isn't working, nor is it likely to be effective for at least the remainder of President Obama's second term. Keynesian economics policies that favor government solutions over free market solutions haven't worked in the past, and they certainly won't work in a highly competitive global economy. Wasting money of failed projects like Solyndra, implementing job killing policies like blocking the Keystone Pipeline and Obamacare and allowing the EPA to impose costly new policies like the RFS2 program that drives up food and energy costs simply isn't a fiscal policy that will drive economic growth. We are 5 years into the Obama administration and unemployment is still higher than when he first took the office. Doing more of the same simply isn't going to change much.

That is the long-term view, what is most important now however is how the markets will react in the short-term to today's, 09/18/2013, Fed's decision on the "taper." This article does a good job detailing the likely impacts of today's Fed action.

Key Points:

1) Expect a small, even symbolic, cut in the Fed's QE program of maybe $10 billion per month to start.

2) Expect the Fed to start by slowing the purchases of the treasuries, and continue the purchases of the mortgages.

3) Expect the Fed to keep short-term rates at zero. Increasing the short-term rate would not be expected until the taper was nearing the end or has ended.

4) Current measurements for both inflation and unemployment are off their targets, and the targets are levels at which the Fed would start to pay attention, they are not automatic trigger levels. Both unemployment and inflation are highly dependent upon fiscal policy, and why I wrote the article about the long-term prospects of the "taper."

5) Both the unemployment rate and inflation have been changing for all the wrong reasons. Unemployment has been dropping because people are giving up, and inflation is up due to costly regulations and unease in the Middle-East, not a sustainable job producing surge in demand.

6) Fed expectations for economic and job growth have been too optimistic this year.

In their previous forecast three months ago, Fed officials predicted that the economy would grow between 2.3 percent and 2.6 this year and between 3 percent and 3.5 percent next year. Most economists think the economy will have grown 2 percent - at best - this year and roughly 2.6 percent next year.

What this means is that what matters most is what the Fed says about its forward "guidance."

The Market Reaction:

Equities:

The markets already seem to have discounted a $10 to $15 billion per month cut in QE. If that is what happens, I would expected a muted response from the equity markets, or even a sell-off on the news. If the cut is less than $10 billion per month, I would expect an equity rally. SPDR S&P 500 (NYSEARCA:SPY) would be expected to remain relatively stable if expectations are met, but there is always the chance of a relief rally or sell on the news effect. If the Fed's guidance is that the economy is still struggling, expect equity markets to rally.

Fixed Income:

If the cuts are as expected, I would expect bond prices to be relatively flat. If the Fed alters the mix of starts to cut its mortgage bond buying, In would expect an increase in mortgage rates. I doubt that would happen, and if it does, it would signal optimism by the Fed. If the amount $10 billion or less, expect bonds to rally, more than $15 billion, expect bonds to sink. I would expect iShares Barclay's Ag Bond Index (NYSEARCA:AGG) to remain rather flat if expectations are met. If the Fed's guidance is that the economy is still struggling, expect bond markets to rally.

Gold and Silver:

Gold/SPDR Gold Trust (NYSEARCA:GLD) and silver/iShares Silver Trust (NYSEARCA:SLV) is where most of the action is likely to be. Some pros have the taper taking gold down to $650, others are saying it is losing or has lost its luster, and as I write this gold is resting on $1,300/oz. I would expect gold and silver to sell off on almost any news from the Fed. The fact that the Fed is starting the "taper" is bad news for gold and silver, and any cuts above expected would even be worse for the precious metals. Gold may have a short-term dead cat bounce if the cuts are less than expected, but the bounce would almost certainly be short-term in nature. If the Fed's guidance is that the economy is still struggling, expect the gold and silver markets to rally...in the short-term.

In conclusion, the key to watch for today is that the "taper" is between $10 to $15 billion, focused on reducing treasury purchases and the Fed will likely reduce its outlook for economic growth. That will signal to the markets that the "taper" will take longer than anticipated, and unemployment can be expected to remain higher, and inflation lower than expected. That may cause the bond and equity markets to rally, and provide support for a short-term rally in gold. If on the other hand the Fed says things are looking fine going forward, I would expect the opposite and rates to increase faster than expected, which should slow the advance in equities and send gold and silver tumbling.

Disclaimer: This article is not an investment recommendation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.

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.