Sep 20, 2013

    Fed holdback leaves investors confused


    WALL Street's knee-jerk reaction to the Federal Reserve choosing to keep the pedal to the monetary-policy metal was loud and clear: Buy! Buy! Buy!

    However, that initial exuberance masks a nagging worry and no shortage of confusion over the Fed's reluctance to act, after the central bank had positioned markets for a reduction in its US$85 billion (S$106 billion) per month bond-buying programme. It left many investors in a fog about what comes next.

    The trading day certainly did not unfold as expected. The vast majority of investors were bracing themselves for a modest reduction in the Fed's monthly purchases of US Treasury debt and mortgage bonds.

    But the Fed - citing concerns over low inflation, the impact of a recent rise in long-term interest rates on housing, and headwinds from Washington's "fiscal retrenchment" - said it needed to see more economic improvement before acting.

    "The Fed is sending a message that the economy is weak, and that's confusing," said Mr Wayne Kaufman, chief market analyst at Rockwell Securities.

    Fed chairman Ben Bernanke first suggested in May that the central bank could pull back on its bond purchases late this year if economic growth continued to gain traction, as he predicted it would in the second half of this year and next year.

    That caught markets flat-footed in the spring and pushed up bond yields and mortgage rates by more than a percentage point over three months, slowing momentum in the United States housing-market recovery.

    That "tightening of financial conditions" over the summer could, if sustained, slow improvement in the economy and the labour market, the Fed said on Wednesday.

    Some pointed out that Congress had made life difficult for the Fed by hitting the economy with government spending cuts and higher taxes earlier this year.

    Now, the prospect of a government shutdown next month if Congress can't agree on a new budget and a rise in the debt ceiling in coming weeks is raising new concerns.

    And that leaves investors wrestling with whether to be happy or worried.

    On the one hand, "people are going to say: 'Hey, great, the Fed is back in the game, they've still got our backs'," said Mr Brad McMillan, chief investment officer at Commonwealth Financial in Waltham, Massachusetts.

    On the other hand, "from a real economy standpoint, what (this decision) says is the Fed is more nervous about the economy than generally perceived", he said.