Do Stocks Tank When QE Ends? - Real Time Insight

Zacks Investment Research
Posted: May 22, 2013 7:42 PM

Much like the London Clock Tower with the same name, all eyes were fixed on Chairman Ben Bernanke’s testimony today.

The Big Ben Statement

In today’s Bernanke briefing on the Hill, his big statement was–

"A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further.”

Stocks went up upon publication of this comment, then drifted. 

The benchmark 10-year U.S. Treasury rate shot up 10 basis points to above 2% during the morning briefing.  Tapering the Fed’s quantitative easing (QE) each month would send long-term bond yields higher.

The Federal Open Market Committee (FOMC) minutes from the April 30-May 1 meeting were released in the afternoon.  They pointed out several future directions. 

  • A "number" of central bank officials could taper bond purchases as soon as the next FOMC meeting in June. 
  • A "couple" of Fed officials said the Fed might have to ease more if inflation fell further.
  • One Fed official wanted to stop bond purchases immediately. 
  • One Fed official wanted to increase the size of the program.

At this point, stocks turned noticeably lower.

Big Ben’s Ten Key Points:

(1) Unemployment is still too high.  8 million people are working part-time that would prefer full employment.  Slack prevents young people from getting skills. 

(2) The U.S. economy is held back by headwinds.  Some headwinds have dissipated from QE.  QE increased consumer confidence and spending. Auto and housing sales are up, as is home construction and prices. The housing market improvement supports real estate, brokerage, and home furnishings industries.

(3) QE has offset deflationary pressures.  Inflation is at or below the Fed’s 2% target rate.  Financial conditions in Europe have improved somewhat.  Credit conditions have eased in the U.S.

(4) Federal fiscal policy is restrictive.  The Fed expects Federal budget tightness to exert a drag amounting to -1.5% of GDP in 2013.  Total U.S. government employment has come down by -800,000 jobs recently. In the first quarter, GDP was up +2.5%, as private demand offset the drag from government spending. 

(5) Bernanke feels current monetary policy cannot fully offset the coming GDP budget loss.  Budget cuts need to be more gradual in the near term, and more substantial in the long term. Bernanke spoke about the benefits from a "grand bargain" budget deal. He believes it would inspire confidence in markets and households, which would help strengthen the economy and take some of the burden off the Fed. It also would make it easier for the central bank to exit.

(6) QE is addressing a short-run cyclical GDP gap.  Long-run GDP growth underpinnings are not the Fed’s job. 

(7) Low rates could undermine financial stability.   QE’s most significant cost comes from a reach for yield. Bernanke said the Fed is working to address this through increased monitoring of institutions, and implementation of existing bank reforms. He added, significantly, that low GDP growth has serious financial instability concerns too.

(8) The Fed is buying at a flow rate in QE3.  This is different from earlier QE1 and QE2 programs. 

(9) The Fed will maintain highly accommodative policy as long as needed. The Fed could increase or reduce its MBS and Treasury bond buying policy going forward. 

(10) Sustainable labor market improvement needs to be seen. Recalibration will take in new labor market information as it comes in. QE will continue until improvement in the labor market is nearer its ‘Way Station’ at a 6.5% threshold rate. 

How Investors View Big Ben

One influential commentator said Bernanke's testimony and earlier comments from NY Fed President William Dudley "appear consistent with our expectation that tapering could start by the September FOMC meeting."

Another said the Fed is trying to keep stock markets from “pricing in a complete elimination of QE at the first sign of cutback.”

Warren Buffet said it would be the "shot heard round the world" when QE comes to an end. There are various scenarios of how it could happen. The next few Fed meetings are: June 18-19, July 30-31 and September 17-18. 

A Real Time Insight Debate

Taking all of this in, what do you think?

When Ben Bernanke pulls away the punchbowl and brings an end to QE, what will be the consequences for the stock market?

  1. No effect
  2. Stocks will tank
  3. Stocks will rise
  4. Stocks will range-trade

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