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Fed Tapering: Not If, But When

August 22, 2013

As we noted recently, the Federal Reserve has explicitly mentioned tapering in their recent communications, and President Obama has commented numerous times on avoiding another round of asset bubbles. Today’s Fed minutes were non-committal on when tapering will take place, but still expressed the desire to step away from the controversial bond-buying program. Below is one of the key QE-related portions of Wednesday’s Fed minutes:

While a range of views were expressed regarding the cumulative improvement in the labor market since last fall, almost all Committee members agreed that a change in the purchase program was not yet appropriate. However, in the view of the one member who dissented from the policy statement, the improvement in the labor market was an important reason for calling for a more explicit statement from the Committee that asset purchases would be reduced in the near future. A few members emphasized the importance of being patient and evaluating additional information on the economy before deciding on any changes to the pace of asset purchases. At the same time, a few others pointed to the contingent plan that had been articulated on behalf of the Committee the previous month, and suggested that it might soon be time to slow somewhat the pace of purchases as outlined in that plan.

It is noteworthy that one member called for “a more explicit statement from the Committee that asset purchases would be reduced in the near future”. The term “would” was used instead of “may”. The minutes also included the statement below:

The Committee decided to indicate in the statement that it “reaffirmed its view”–rather than simply “expects”–that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.

Again, we have a specific reference to ending the asset purchase program. They chose to use “after the asset purchase program ends”, which implies it will end in the not too distant future.

Knee-Jerk Reaction “Tapering Is Coming Soon”

Wednesday’s weakness was not all that surprising since technical concerns outlined in last weekend’svideo were still in place. Following the release of the Fed minutes, bonds were weak. If you believed QE was going to continue unabated, which involves the Fed buying bonds, you would probably gravitate toward bonds rather than away from them. That is not what happened. The chart below shows how TLT moved before and after the 2:00 p.m. EDT Fed release.

Gold Also On Tapering Bus

If you felt the Fed was going to continue to print money unabated, you would expect inflation concerns to increase. It stands to reason gold would catch a bid if the market felt tapering was not on the agenda. That is not what happened. Gold rallied, but closed down for the day.

Investment Implications

As noted on Twitter (below), markets may need some time to fully digest the new information from the Federal Reserve. Having said that, the bearish warning flares we covered last Friday morning tell us the bias heading into Wednesday’s session was shifting toward “risk-off”.

Stocks also expressed concern after a quick review of the latest Fed-speak. Our market model has been very helpful in terms of having us reduce our exposure to stocks significantly before Wednesday’s sell-off, which is shown below via the S&P 500 ETF (SPY).

The S&P 500 still has possible support near 1635. If support holds, we are open to redeploying some cash at a measured pace below 1685. Above 1685, our model will have us add to our positions in technology (QQQ), small caps (IJR), mid caps (MDY), and the S&P 500 (SPY) at a faster rate. As of Wednesday afternoon, the bulls still maintained a very slight advantage over the bears from a technical perspective. The balance of power may flip if the S&P 500 closes below 1646 for more than a day or two.

The periodic symbol for gold is AU which come from the Latin for gold aurum.
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