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Did the Federal Reserve Just Kill the Stock Market Rally?

Finance

Did the Federal Reserve Just Kill the Stock Market Rally? image 200613 PC lombardiWhat a remarkable past 20 hours it’s been…

Yesterday afternoon, the Federal Reserve announced it might cut back on its $85.0-billion-a-month money printing program later this year.

The Dow Jones Industrial Average tanked 200 points following the news (and continues to fall this morning), European stock markets fell about two percent, Asian stock markets saw about the same, bond yields jumped to their highest level in years, and gold bullion prices are getting hit hard this morning.

Now, here’s an opinion on what’s really happened over the past 20 hours, and what will happen going forward, that you won’t read anywhere else:

Back in December of 2012, the Federal Reserve announced it would continue with its quantitative easing program until the unemployment rate in the U.S. economy fell under 6.5% and inflation increased beyond 2.5%.

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If I heard the Fed Chairman correctly yesterday, those targets are out the window now.

In a press conference after the Federal Open Market Committee (FOMC) meeting minutes were released, Federal Reserve Chairman Ben Bernanke said the central bank might change the pace of the asset purchases later this year depending on the performance of the economy. He hinted that the Federal Reserve may even end quantitative easing by mid-2014 if the outlook on the U.S. economy remains as it expects. (Source: Financial Times, June 19, 2013.)

The Federal Reserve expects the U.S. economy to grow between 2.3% and 2.6% this year and between 3.0% and 3.5% in 2014. And the central bank doesn’t expect the unemployment rate to decline below 6.5% until 2015. (Source: Economic Projections, Federal Reserve, June 19, 2013.)

So the tone of the Federal Reserve has changed from “we’ll keep money printing going until the unemployment rate hits 6.5% and inflation goes to 2.5%” to “we might start pulling back on money printing later this year if the economy continues to improve.”

Dear reader, I have been writing about this for months. I’ve even created several video presentations on the topic:

By creating trillions of dollars in newly printed money, the Federal Reserve inadvertently created a bubble in the bond market and spurred a big rally in the stock market.

The bond market bubble, which I have been warning would burst, has already started to do so. In my opinion, the Fed sees a stock market bubble coming too and put the brakes on that rally yesterday by making it very clear to market participants not to count on quantitative easing to boost the market higher.

But here’s what wasn’t said yesterday:

By the end of this year, the Federal Reserve will have printed just under $1.0 trillion in new money—roughly equal to the U.S. government’s budget deficit for the year. What a coincidence.

So if the Federal Reserve stops buying U.S. Treasuries, who will step in and buy them? We know foreign investors have pulled back on buying U.S. Treasuries for a variety of reasons. To attract buyers to U.S. Treasuries in the absence of the Federal Reserve buying them, interest rates on the U.S. bonds will have to rise…and that’s exactly what has been happening in the bond market.

But won’t higher interest rates kill the housing market and stifle an economic recovery that is already questionable?

You’ve got it, dear reader. The Federal Reserve’s comments on pulling back on its money printing program have surely cooled the stock market rally for now. But the real question is: will the Federal Reserve really be able to stop printing money given that 1) the government’s pool of buyers for its bonds has diminished, and 2) higher interest rates will kill the so-called housing and economic “recovery”?

I surely wouldn’t bet on the Federal Reserve pulling back on money printing anytime soon. Any forms of investment that were hit particularly hard by the Fed’s comments yesterday might actually be a buy right now.

Did I just hear someone say “gold bullion”?

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