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Stocks, Dollar, And VIX Not Anticipating Negative Reaction To Fed

 April 26, 2011 12:45 PM

Experience tells us the best approach to this week's Fed trifecta (meeting, statement, and press conference) is (a) to be patient, (b) wait for the news to come out, (c) monitor the market's reaction, and (d) make any adjustments to our allocation if needed. From a contingency planning perspective, it is helpful to study the markets for clues that may foreshadow the reaction to Wednesday's Fed statement and press briefing.

The Fed's recent press release contains an important time change related to this week's statement:

In 2011, the Chairman's press briefings will be held at 2:15 p.m. following FOMC decisions scheduled on April 27, June 22 and November 2. The briefings will be broadcast live on the Federal Reserve's website. For these meetings, the FOMC statement is expected to be released at around 12:30 p.m., one hour and forty-five minutes earlier than for other FOMC meetings.

[Related -Searching For Solid Support In The Face Of Global Headwinds]

From a fundamental perspective there are reasons to be nervous about the approaching end of the Fed's second quantitative easing program (QE2) and possible policy changes to begin mopping up some of the liquidity in the financial system. As we originally presented on March 14, the chart below shows the stock market's negative reaction to the completion of QE1.

[Related -Long-term Relationships and Credit Scores]

For those who doubt whether the end of QE2 is a significant event, the chart below shows the S&P 500's performance after Ben Bernanke's August 27, 2010 Jackson Hole speech, which basically told the markets QE2 was on the way.

The table below shows where top-performing investments congregated post QE1 and after the Fed signaled QE2 (8/27/10 to 3/9/2011). The stark contrast between the left and right columns below tells us it is very important to look for a possible shift in risk appetite between now and the completion of QE2, which is scheduled to end in June.

The April 26 Wall Street Journal contained several articles about the end of QE2. The Journal highlighted our concerns as follows:

So far the Fed has bought $548 billion worth of Treasurys under QE2, according to a Barclays Capital tally, with maturities ranging from 1 1/2 to 30 years, and inflation-protected securities as well. The buying has made up more than 85% of the net $638 billion of bonds the government sold between November and March (Article).

"When QE2 ends in June, then $1.5 trillion worth of check-writing per year basically disappears," says William Gross, who oversees the $1.2 trillion portfolio of Pacific Investment Management Co.

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