The main headline on Yahoo! Finance today says it all: "Will the Market Get What It Wants from the Fed?" What the market wants is more "stimulative actions" via lower interest rates. What it will likely get is the middle ground. Let's take a look at the announcement that will move the markets today.
The three options on the table
At around 12:30 p.m. EDT today, the Federal Open Market Committee will conclude its two-day meeting and release a statement detailing its opinions on the economy and future actions. There are really three options on the table:
- Do nothing: This will likely be met with a negative reaction from the market and is probably the least likely scenario. With Europe muddling through and job growth approaching flat levels, the Fed will likely take some level of action.
- Extend "Operation Twist": The odds-on favorite from the Fed's actions today. Operation Twist is a program where the Fed sells Treasuries with short maturities -- ones that mature within three years -- and buys notes with longer maturities, up to 30 years from now. The intent is to flatten the yield curve and encourage more borrowing. In addition, with lower rates available on U.S. debt, that pushes investors back into stocks, especially ones with yields that surpass government debt. The yield on the Dow Jones Industrial Average (INDEX: ^DJI ) is 2.9%, which is above the recent 2.73% yield on 30-year Treasuries.
- Open up the quantitative easing floodgates again: The final course the Fed could take is beginning another round of quantitative easing, or QE. That move is more aggressive than Operation Twist. The first round of QE began in 2008 and aimed to purchase $650 billion in mortgage securities and other agency debt from the likes of Fannie and Freddie. The second QE was launched in 2010 and moved to purchase Treasuries while also shifting previous spending from mortgage securities to more Treasuries. The end goal is to keep yields on Treasuries down, but it's a more blunt-force method than Operation Twist and can target a wider range of securities.
What's an investor to take away from this?
Which leads us to the natural question in all of this: What kind of effect does the Fed really have anymore? After all, three-year Treasuries are yielding 0.39% while 10-year Treasuries are at just 1.64%. Those are already rock-bottom rates. That's likely why the Fed won't begin a third quantitative easing round today. As a commentator on Bloomberg said this morning, the Fed's cabinet of actions is starting to look threadbare. A third round of quantitative easing might be one of the few major weapons it has left, and is best not used at this point. Likewise, the Fed could use the day's proceedings to double down on its assurances for very low interest rates through 2014.
Looking to stocks
As I mentioned earlier, some of the natural beneficiaries of lower interest rates are rock-solid dividend-paying stocks. Without an alternative to gather much income in government bonds, dividend-payers look pretty attractive right now. In the Dow, the highest yielders -- AT&T (NYSE: T ) and Verizon (NYSE: VZ ) -- are both up over 10% in the past three months, while the Dow is down 3% over that time frame. The rally across the year has pushed their yields down from around 6% to less than 5%. That's still a hefty yield, but shows how the flight to safety and high yields is pushing up the share prices of many safe dividend-payers.
That said, many high-quality Dow companies with solid dividends haven't seen the same rally across the past few months. McDonald's (NYSE: MCD ) is yielding 3.1% due to missing some lofty estimates for same-store sales. Microsoft sports a 2.6% yield and has indicated it'll continue being aggressive about raising its dividend in coming years.
That's not to say these dividend-payers are riskless; Procter & Gamble (NYSE: PG ) is down 3% today after cutting its earnings outlook. If global growth rates continue to slow, many companies will have to turn back estimates and will likely see their share prices fall. However, over a multiyear time frame, with many Dow components trading at P/Es approaching the single digits, they're not priced for a lot of growth either.
Take the long-term view
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