The Markets:

All eyes seemed focused on the Fed last week with testimony on tap from Ben Bernanke, Federal Reserve Chairman.  After all was said and done moving into a long holiday weekend, the Standard & Poor’s 500 stock index gave up around 1.0% last week.  More details as to the Fed Chairman’s remarks follow.

 The Fed’s 360 degree monetary policy

Any time a Federal Reserve chairman speaks before a Congressional committee, there is always the possibility markets will react. Wednesday morning’s testimony didn’t disappoint.

In his prepared remarks (Federal Reserve website), Ben Bernanke initially soothed anxieties that the Fed might start cutting back on its monthly bond purchases of $85 billion. He noted a “premature tightening in monetary policy” could temporarily boost interest rates, which would “carry a substantial risk of slowing or ending the economy recovery.” The Dow quickly jumped nearly 150 points (MarketWatch).

But in response to a question in the Q&A session, Bernanke threw the bulls a curve ball when he said the Fed “could take a step down in our pace of purchases” in the next few meetings. He heavily qualified the comment, saying any pullback in bond buys would depend on upbeat economic data and it would not be a straight line to an exit. But the market had been put on notice (MarketWatch, CNBC).

At midday, the release of the Fed’s minutes from its May 1st meeting continued to dampen buying enthusiasm with the remark, “A number of participants (Fed members) expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth.”  Not surprisingly, there was plenty of disagreement as to what constituted evidence of sufficiently strong and sustained growth. Furthermore, the minutes were peppered with worries about “downside risks.”

Confused? A New York Times headline summed it up well: Fed Endorses Stimulus, but the Message Is Garbled.  Many analysts had been speculating that any reduction in bond buys might begin in the fall, so talk from the Fed that we might see a pullback by June was more aggressive than had been anticipated.

Why the importance? Recall in recent market summaries that one of the “legs on the stool” that has been supporting stocks has been the Fed’s very aggressive monetary policy. Yes, the plan is controversial and chatter the Fed might be getting ready to taper, even if it’s modest, was enough to nudge stocks lower.

In addition, speculation the Fed could soon cutback also encouraged some selling in the Treasury market, helping to lift the yield on the 10-year bond above 2% for the first time since March 15 (U.S. Treasury).  The current bond buying program has also kept interest rates low, and the Fed’s direction will also likely affect bond prices.

Bottom line

Given Bernanke’s remark that the Fed could start tapering bond buys in the next few meetings, coupled with a more hawkish-than-expected tone in the minutes, suggests the center of gravity is drifting towards a slightly less aggressive monetary policy.  However, the Fed gave itself plenty of room to maintain the current policy and even ramp up purchases if economic growth were to slow too quickly. In other words, it has all of its bases covered and could go in any direction – a 360 degree policy – if conditions warrant.

Bernanke’s testimony and the minutes seemed to embody the observation that the Fed could go in either direction. At this time, the consensus favors no change at the June 18-19th meeting. We will keep you apprised.

We hope you all had a great Memorial Day weekend, and as always, we are here to serve.  Let us not forget those who were affected by last week’s tornadoes as they need our support even more as time passes and the news headlines shift.

God Bless,

Your TEAM at F.I.G. Financial Advisory Services, Inc. 

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