The Federal Open Market Committee (FOMC) voted to shift its monetary policy on 18 December. Monthly purchases of agency mortgage-backed securities and longer-term Treasury securities will each be reduced by $5 billion, to $35 billion and $40 billion, respectively. This tapering is significant in that it represents the beginning of the end of quantitative easing, but it is subtle in terms of the likely short-term impact on the economy.
The shift comes as the committee members’ view of the economy has become more optimistic relative to earlier in the year. Though Boston president Eric Rosengren thought the shift was premature and dissented, the consensus among committee members was that now is the time to start weaning the economy off of cheap money. Whether the timing and the magnitude of the shift is correct is something to be debated in the years to come. Even our ability to look back at this decision years from now won’t give us the right answer, because all variables going forward would change if a different decision had been made yesterday.
Yesterday’s announcement ends the speculation about when tapering will begin. Though less uncertainty is generally a positive for the stock market, I don’t view the immediate reduction in purchases as being large enough to have any significant short-term impact on either the stock or the bond market. Even with likely further reductions at future meetings, the Fed’s cumulative bond purchases could still exceed $400 billion in 2014.
More importantly, the announcement is not a reason to alter your portfolio allocations. Economists and market strategists have been wrong about what the Federal Reserve will or won’t do for several years and there is little reason to expect their forecasts to be accurate going forward. This fact alone should be reason enough not to alter your portfolio right now.
The challenge always facing central bankers is that economic and monetary policy cannot be subjected to controlled studies the way pharmaceuticals are. When a change is made to monetary policy, we will never know what might have occurred if a different decision had been made. We can theorize about what might have happened, but that’s it. The best an investor can do is to accept the uncertainty and stay diversified. Over the long term, stocks are the best inflation hedge, while bonds can give you income and—when held to maturity—preservation of wealth.
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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.
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