The Coming Fed Surprise

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.

The market is not doing much as we await the policy statement from the Federal Open Market Committee at 2 p.m. EST. Just before 1:30 p.m. EST, the Dow Jones Industrial Average  (DJINDICES: ^DJI  )  was down six points to 15,868. The S&P 500 (SNPINDEX: ^GSPC  ) was down six points to 1,775.

The Federal Reserve has pursued two policies to stimulate the economy and the jobs market. The first is the zero interest rate policy in which the Fed lets banks borrow from it at rates now targeted between 0% and 0.25%. The second policy is quantitative easing through the Fed's monthly $85 billion purchases of long-term assets, split between $40 billion in mortgage-backed securities and $45 billion worth of long-term Treasuries.

The Federal Open Market Committee has made it clear that the zero interest rate policy will continue for a few years no matter what other actions the central bank takes. Federal Reserve members have been debating whether to continue the second program and also other possible actions the bank could take. This is where investors could be surprised, if the Fed takes other actions besides a decision on whether to taper.

Possible actions that have been hinted at:

-- Lowering the publicly stated unemployment target from 6.5% to 5.5% with regard to the timeline for raising interest rates.

-- Cutting the interest on excess reserves for banks from 0.25% to make it effectively 0% once you include the FDIC assessment rate, or cutting it to 0% to make it effectively negative.

-- Changing forward guidance to give more specific information as to when the Fed will taper or when the federal funds rate will be raised.

-- No longer reinvesting earnings and principal payments from its holdings.

Whatever the Fed is planning, we'll know in about 30 minutes.

What's an investor to do?

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  • Report this Comment On December 18, 2013, at 2:15 PM, TMFDanDzombak wrote:

    Changes in Fed policy

    $10 billion Taper

    "Beginning in January, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $35 billion per month rather than $40 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $40 billion per month rather than $45 billion per month."

    Change in unemployment target [ALL CAPS is my emphasis]

    "The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate WELL PAST the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal."

    http://www.federalreserve.gov/newsevents/press/monetary/2013...

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