Market Commentary: Liquidity

Joe PreisserJoe Preisser, Portfolio Specialist, Brinker Capital

The powerful figure of the Federal Reserve Bank of the United States (Fed) continues to hold sway over the global landscape, as the collective eyes of investors around the world watch intently for any discernible hint of a shift in policy, which when detected, has radiated across the marketplace. During the course of the past five weeks, the American Central Bank has launched a veritable public relations barrage in an effort to stave off the steep sell-off in risk assets that accompanied comments issued by Chairman Ben Bernanke following the conclusion of a meeting of the Federal Open Market Committee on June 19.  During the ensuing press conference, Mr. Bernanke suggested that if the economic data from the U.S. continued in its current pattern of improvement, the time may be near for a measure of the support the Fed has provided to the U.S. economy. namely the $85 billion per month of asset purchases currently being made, to be curtailed.

7.26.13_Preisser_Liquidity_2Market participants reacted to the Chairman’s comments by throwing what has been called the “taper tantrum”(Bloomberg News), which culminated in a 4.8% decline in the Standard & Poor’s 500 over the course of five trading days, and a .35% rise in yields on the 10-year U.S. Treasury note during the same time frame.  The Central Bank’s officials, and especially the Chairman himself, have proven themselves particularly deft at quelling the market’s concerns in the day’s since, and in so doing have provided a catalyst that has sent stocks rallying around the world, and those listed in the United States to record highs. The volatility witnessed over recent weeks highlights the market’s continued dependence on the liquidity provided by the Fed, and further illustrates the difficulties surrounding its eventual removal, which may begin as early as September.

Reassurances from Fed officials—that the Central Bank remains committed to the continuity of its current accommodative stance for the foreseeable future—poured forth into the mainstream media as the selling pressure built within the marketplace. Beginning on June 25, the President of the Federal Reserve Bank of Dallas, Richard Fischer, and Minneapolis Fed President, Narayana Kocherlakota both issued comments designed to emphasize the fact that the Central Bank would keep in place its support of the economic recovery in the U.S. Mr. Kocherlakota was quoted by Bloomberg News on the 25th as saying, “The committee should continue to buy assets at least until the unemployment rate has fallen below 7 percent.  The purchases should continue as long as the medium-term outlook for the inflation rate remains below 2.5 percent and longer-term inflation expectations remain well anchored.” What have been categorized as unusually direct statements, of these two, non-voting members of the Committee (Bloomberg News), served to soothe concerns among investors, and were followed in short order by those of Richmond Fed President, Jeffery Lacker, who helped to further assuage any lingering uncertainty.  Mr. Lacker reiterated the fact that continued, substantive labor market improvement was necessary for the tapering of asset purchases to commence, and noted his confidence that deflation was not an issue (Bloomberg News), which helped to accelerate the rebound in risk assets.

7.26.13_Preisser_Liquidity_3The highly anticipated release of the June employment report was well received by the market. Although it revealed the creation of 195,000 jobs within the United States, which exceed the consensus estimate of 165,000 (New York Times), it fell short of the whisper number of 200,000 that had circulated, and the unemployment rate remained stagnant at 7.6%. The report buoyed the belief that the Fed would need to maintain its current pace of asset purchases for a longer period of time than many had feared as the pace of job creation, although improving, does not warrant tapering.  Jan Hatzius, the chief economist at Goldman Sachs, was quoted in the New York Times on July 5—“Beyond the headline numbers for job growth, it gets a little more mixed. There is still a lot of slack in the labor market.”

Stocks received a further lift from Chairman Bernanke who, in answering audience questions following a speech he delivered at the National Bureau of Economic Research conference on July 10, made an effort to stress the fact that the Central Bank remained committed to furthering the economic recovery.  Mr. Bernanke was quoted by the Wall Street Journal—“There is some perspective, gradual and possible change in the mix of instruments.  But that shouldn’t be confused with the overall thrust of policy, which is highly accommodative.” The Chairman once again reiterated this pledge in testimony before Congress on July 17—“Our intention is to keep monetary policy highly accommodative for the foreseeable future, and the reason that’s necessary is because inflation is below our target and unemployment is still quite high” (New York Times). These statements served to further the belief that has come to be known as the, Bernanke Put for the Chairman’s willingness to intercede when financial market’s struggle, which has been perceived to offer protection to investors, remains in place and provided further support to risk assets.

7.26.13_Preisser_Liquidity

Although benchmark indices in the United States have risen to record levels, a measure of uncertainty lingers beneath the surface as the inevitability of the scaling back of the Fed’s asset purchases remains, along with the question of who will succeed Mr. Bernanke as the next Chairman of the American Central Bank.  Despite no official word having been offered that his tenure atop the Federal Reserve will come to an end in January, this is widely considered to be the case.

Speculation as to who will replace Mr. Bernanke has risen to the fore with the two perceived leading candidates appearing to be the Fed’s current No. 2, Janet Yellen, and former Treasury Secretary, Larry Summers. According to the Wall Street Journal—“The race to become the next leader of the Federal Reserve looks increasingly like a contest between two economists: Lawrence Summers and Janet Yellen.”  In addition to the questions surrounding the identity of the next head of the Central Bank, a recent poll of economists, conducted by Bloomberg News, revealed the belief among a majority of those queried that the Federal Reserve would in fact begin tapering in September. With summer’s effusive glow illuminating Wall Street and the record gains of its equity markets, the cool winds of fall hold within them the possibility of bringing the unwelcome specter of volatility as these issues seek resolution.

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