U.S. Fed monetary policy and its' impact on your investments

The recent market volatility we’ve been experiencing over the past several weeks has led me to write this. We have had more than the usual number of calls and questions and we felt this might be helpful.

U.S. monetary policy related to the tapering of stimulus to the economy has been getting much media attention. It has resulted in more than usual market volatility and has led to an increase of approximately 1.0% in the U.S. 10 year Treasury and the Canadian 10 year Bond yields since May, 2013.

Our expectation is that starting in late 2013, the Feds will start withdrawing liquidity from the market (tapering their Quantitative Easing Program) and there will be corresponding interest rate hikes. To date, short-term yields have not changed, the longer term 10 year yields have risen, and the yield curve has steepened. A steep yield curve is generally a positive for equities over bonds and that is our recommended positioning of your investments.

As has occurred historically, longer term yields have already risen before the Fed have actually announced the official policy change. The expected shift in Fed policy is causing uncertainty in the markets, especially the fixed income markets. Other effects include negative impacts the emerging markets, and the defensive, interest rate sensitive sector of the stock market has suffered, while the cyclical stocks have posted modest gains. However, as reported by ScotiaMcLeod’s Portfolio Strategist, Vincent Delisle, “although the initial equity market reaction to Fed tapering has been mostly one of discomfort, we believe upside potential lies ahead.”

To underscore Delisle’s comments, the U.S. Federal Reserve Board would not be considering reducing their liquidity support for the U.S. economy if things had not improved sufficiently since it was introduced following the 2008 financial crisis. However, the withdrawal hinges on positive economic activity and confirming statistics, and unfortunately the various economic activity reports give mixed messages -hence the ongoing attention to each economic report and the resultant market uncertainty related to what will be decided and when!

As you know, we believe in balanced, diversified portfolios of good quality stocks and bonds that are held for the long-term.

I hope this provides some insight into the current bond and equity market conditions.