The Fed Should Talk About Tapering. Here’s What Could Happen to the Stock Market.

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Federal Reserve Board Chairman Jerome Powell. The Fed has limited margin for error in what the central bank says about its current easy-money policy.

Drew Angerer/Getty Images

Investors expect the Federal Reserve to remain supportive of the economy and financial markets. But the central bank has limited margin for error, and any miscues on messaging could be costly to the stock market.

Markets do not expect the Fed to make any sudden or drastic changes to its current easy-money policy. The 10-year Treasury bond’s yield has fallen to 1.51% from 1.64% a month ago, even as inflation has run hotter than expected. The Nasdaq 100, an index of large capitalization and fast-growing technology companies, is up more than 5% in the past month. Growth stocks see a significant valuation booster when long-dated bond yields remain low, as growth companies expect growing profits on a particularly long-term basis. But while investors expect the Fed to soon reduce the size of its bond-buying program, which would raise bond prices and lower their yields, most don’t think the Fed will do so immediately or drastically.

“It’s pretty clear that the market expects Fed Chair Powell to strongly reiterate his stances,” writes Chris Senyek, chief investment strategist at Wolfe Research. 

Now, the Fed could stoke a harsh move downwards in tech stocks if it doesn’t choose its words wisely. With the Nasdaq 100 hovering just below a new all-time high set on June 14—accompanied with a 10-year Treasury bond yield that’s well below its 2021 peak of 1.75%—tech stocks are vulnerable to a downward jolt if the Fed misspeaks. Senyek notes that the Fed may indeed be more ready to taper—or reduce the size of its bond-buying program—than some appreciate. He cites the recently hot inflation. To be sure, most market participants see inflation as transitory, a result of a natural year-over-year bounce from low prices during last year’s lockdown. Even so, if the Fed speaks in a way that indicates it will begin tapering before the end of the year—which is the expected timing—stocks could fall sharply.

“With both stocks and bonds currently ‘priced for perfection,’ the slightest miscommunication could spark a sharp selloff,” says Senyek, who cites the Nasdsaq 100’s recent rise.

Watch to see if the Fed is about to begin tapering, or is merely considering the move in the coming quarters.

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Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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