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How the Fed Will Move the Dow This Afternoon

By Dan Caplinger – Mar 19, 2014 at 6:30AM

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The Federal Reserve's decision this afternoon has market-moving potential, especially if the Fed strays from its previous course. Find out what's at stake.

The Dow Jones Industrials (^DJI) were largely stuck in a holding pattern into midday trading, falling just three points as of 12:30 p.m. EDT on what appeared at first glance to be a quiet day in the markets. Yet with the Federal Open Market Committee today wrapping up its latest meeting on monetary policy, investors are looking to Fed Chairwoman Janet Yellen and her team to determine whether their guesses about the central bank's taper will prove correct. What the Fed decides will have a major impact on the multinational corporations that make up a big portion of the Dow.

Source: Dan Smith.

What's at stake
So far, the Fed has established a set pattern in its past reductions of bond-buying activity, cutting its monthly level of purchases by $10 billion at each of the two most recent meetings. Most analysts expect that trend to continue, with total bond-buying falling to a $55 billion monthly pace after this meeting.

Economic conditions over the past few months, however, have called that consensus into question. Sluggish performance throughout the winter months made many economists wonder whether a pause in the Fed taper would help support a struggling economy. Yet with some more encouraging figures being issued more recently, most analysts no longer expect that pause. Indeed, some have taken the opposite view, arguing that the Fed should accelerate its withdrawal from quantitative easing by tapering at a faster pace in order to hasten the end of distortive effects on the financial markets.

How stocks could move
The financial markets have to date generally applauded the measured pace of the Fed taper. In particular, bond yields haven't risen in the way that many had expected, and that in turn has had a somewhat favorable impact on the 30 Dow companies. Even though their share-price movements in 2014 haven't reflected it, the multinationals within the blue-chip index should see some benefits from currency movements, as the dollar has particularly weakened against the euro in part because of the failure of higher interest rates to materialize.

All that could disappear, though, if the Fed tapers more quickly than expected. In that case, bond yields could rise more substantially, making the dollar look more attractive. That would be bad news for consumer giants Coca-Cola (KO 0.97%), McDonald's (MCD 1.32%), and Procter & Gamble (PG 1.54%), which rely on revenue from worldwide sources to drive overall results. In the recent past, a strong dollar has weighed on earnings growth, making their key international operations less profitable in U.S. dollar terms. Currently, those stocks are likely to get some help from currency trends, but an aggressive Fed could turn that market dynamic on its end.

Conversely, a halt to tapering would have more dramatic implications for the state of the world economy. Caterpillar (CAT 2.46%), for instance, has rebounded sharply on the notion that the U.S. economy's steady expansion can help the heavy-equipment maker survive a slowdown in the Chinese economy. If the Fed's decision reflects greater doubt on the U.S. recovery's sustainability, Caterpillar and other economically sensitive stocks could drop sharply.

Wait and see
In the grand scheme of things, a single Fed decision shouldn't make or break the markets over the long run. In terms of today's Dow, though, what the Fed does has dramatic implications for the average and for its component stocks.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola, McDonald's, and Procter & Gamble. The Motley Fool owns shares of Coca-Cola and McDonald's and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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