Markets & Economy
Joe Davis on the Fed announcement
June 25, 2013
Rebecca Katz: So Joe, Ben Bernanke spoke, the markets have reacted. Can you explain to us really what was the crux of the discussion yesterday and why this reaction? Is this bad news or good news?
Joe Davis: Well certainly in our mind, it's good news longer term that the Federal Reserve is more seriously contemplating reducing how much they have been pursuing quantitative easing or expanding the size of their balance sheet, and the market has just been trying to ascertain for some time as to when that may slow down, the so called QE3, as well as when they may terminate that plan, and Ben Bernanke yesterday not only did in a statement but more importantly in the press conference, in the Q &A just provided, again, reaffirmed that they are thinking about that more seriously than perhaps would they been three or six months ago. Now why they're doing so is because, certainly in our opinion, the market and the economy has less downside risks than perhaps it would've had at the beginning of the year. So broadly speaking, this is good news because the Federal Reserve is coming closer to the realization that the US economy is stronger today than it was a year ago and so does not need the sort of insurance, so to speak, of additional quantitative easing. So I would view this as good news for long term investors, for you and I, and for the listeners at home and at work, but the market certainly is not thinking about that, at least today.
Rebecca Katz: But this was always structured as a temporary program, so I'm a little surprised at the reaction because at some point, it had to taper off.
Joe Davis: Sure, sure and again, I think it's—again, it's—I think part of what the market, the bond market and financial markets are trying to think through, Rebecca, is what we hear so called tapering. So again, it's this sort of question of when the Federal Reserve will slow the rate with which their balance sheet continues to expand by buying US treasury securities and buying mortgage-backed securities, right? Now, again, where I think the market is getting ahead of itself is the distance between when they may start to slow that rate of purchase and ultimately when they may raise the federal fund rate, which is still at zero, that that second window is fairly long more likely than not, and so I think the market's getting ahead of itself a little bit but nevertheless. that's why I think we're seeing the sort of market volatility we're seeing.
Rebecca Katz: So just for some of us who may not've followed why the Fed was really doing this, so they were buying bonds, expanding their balance sheet and that was to keep rates low?
Joe Davis: Well, not just to keep short rates low. We all know that they're at zero, right, so the so-called zero bound, so this was—this so-called unconventional policy of purchasing a longer maturity or longer duration government securities was to lower the interest rate paid on longer term asset prices and fixed income securities. In other words, expanding the so-called accommodation that they would have loved to have done at the short end but given that's zero, they couldn't do [it] any longer, so extended out the whole treasury yield curve, and why that, in their mind, was positive because they're lower—the ability to lower mortgage rates and to lower corporate borrowing rates and so forth but again, we as a firm we've had some concerns that monetary policy may, quite frankly, have been working too well in the sense of investors globally, perhaps taking on too much risk in some segments of the marketplace. So I'm certainly not surprised to see this sort of rise in volatility that we've seen over the past several days.
Rebecca Katz: Okay. Our next question is from Robert in Hillsboro, California, who says, "How much of a correction in the equity market is likely to result in the event that the Fed sharply cuts back on quantitative easing?" Now they're not signaling that they would make a sharp cut, but they haven't done anything yet and we've already seen a steep decline in the equity markets over the last two days, so what are your thoughts on that?
Joe Davis: Oh, boy. Clearly when monetary policy becomes much tighter than expected and again, it's that word you use, Rebecca, relative to what's expected in the person's question, client's question. Hey, in any one day, that same day or that same week, yeah, I think volatility potentially could really rise, but again taking a step back as long term investors where we have historically been very successful, why we've been successful, as you say, what's the long term implication of that, right? So if they are tightening more aggressively than potentially was anticipated, that means the economy and the labor market is even stronger than they were previously anticipating three or four years ago, again, under this hypothetical scenario. So a longer term, again, this would come back to good term for global investors. It would not feel like it potentially that they are weak but investing is not about weekly movements, but we do. We have to have the fortitude to bear it. We really do.
All investing is subject to risk, including the possible loss of the money you invest.
Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
Investments in bonds are subject to interest rate, credit, and inflation risk.
This webcast is for educational purposes only. We suggest you consult a financial or tax advisor about your individual situation.
© 2013 The Vanguard Group, Inc. All rights reserved.
Vanguard's chief economist weighs in on Federal Reserve policy
The markets have been waiting for the Federal Reserve to taper its bond-buying program, and even the hint of such a move by Fed chairman Ben Bernanke sent shocks through stocks. Vanguard chief economist Joe Davis explains why the Fed's action may reflect good news for the economy despite the turmoil in the financial markets.
Other excerpts from this webcast:
- All investing is subject to risk, including the possible loss of the money you invest.
- Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
- Investments in bonds are subject to interest rate, credit, and inflation risk.
- This webcast is for educational purposes only. We suggest you consult a financial or tax advisor about your individual situation.
© 2013 The Vanguard Group, Inc. All rights reserved.