Why the FOMC Statement Matters for the Dow

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

We're less than 20 minutes away from the release of the Federal Open Market Committee statement and Fed Chairman Ben Bernanke's ensuing press conference. The stock market today is relatively unchanged as we wait to see what the Fed is thinking. As of 1:15 p.m. EDT the Dow Jones Industrial Average (DJINDICES: ^DJI  ) was down 45 points to 15,485. The S&P 500 (SNPINDEX: ^GSPC  ) was down 3 points to 1,701.

To review, as part of its quantitative-easing program, the Federal Reserve is purchasing $85 billion worth of long-term assets each month -- $45 billion in long-term Treasuries and $40 billion in mortgage-backed securities. This is an effort to keep interest rates and mortgage rates down and the economy growing, which will hopefully lead to the Fed's mandated goal of full employment.

The Fed has indicated that it would begin to pare back its asset purchases when unemployment fell between 6.5% and 7%, when inflation rose past the Fed's target range of 2% to 2.5%, or when long-term inflation expectations took off. Currently, unemployment is at 7.3%, inflation as measured by core PCE is 1.2%, and five- and 10-year inflation expectations are at 2% and 2.2%, respectively.

After the June FOMC meeting Ben Bernanke held a press conference, saying the Fed could begin tapering as soon as the end of the year. Markets, especially the bond market, sold off, resulting in higher Treasury and mortgage rates.

10 Year Treasury Rate Chart

10 Year Treasury Rate data by YCharts.

Higher rates means increased housing prices, challenging the resurging housing market. We can see the effect of this in today's two U.S. economic releases.

Report

Period

Result

Previous

Housing starts

August

891,000

883,000

Building permits

August

918,000

954,000

Housing starts rose slightly but fell short of analyst expectations of 921,000. Building permits, a sign of future housing starts, fell by 36,000 to a seasonally adjusted 918,000, missing analyst expectations of 955,000.

US Housing Starts Chart

US Housing Starts data by YCharts.

With higher rates beginning to have a notable effect on the housing market, it will be interesting to see what the Fed will say in its statement and press conference. Analysts expect a slight tapering of asset purchases from $85 billion a month to between $70 billion and $75 billion a month. If the Fed surprises the market by announcing substantially larger tapering, the market could easily sell off in a panic.

Foolish bottom line
While the economy is slowly improving, the Dow is down for the day amid uncertainty over what the Fed may or may not do. Long-term investors would do well to ignore the market's ups and downs, focus on their investing plans, and keep their wits about them. As always, opportunities will arise for long-term investors to pick up undervalued companies, you just have to be patient.

One sector that is a beneficiary of higher interest rates is the banking sector. If you missed out on the massive gains in bank stocks over the past few years there is good news: It's not too late. Bargains of a lifetime are still available, but you need to know where to look. The Motley Fool's new report "Finding the Next Bank Stock Home Run" will show you how and where to find these deals. It's completely free -- click here to get started.


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