This past week the minutes from the Federal Reserve meeting were released which revealed aspects of the exit strategy and policy normalization. The announcements are in line with our expectations and the Fed noted that they would be communicating their plans publicly later this year. We expect the Fed’s exit strategy will follow the sequence described below:
The first step in the exit sequence will be ending QE. This was decided at the last meeting that unless the economy takes a significant turn for the worse, this step will take place at the October 2014 Fed meeting. We believe that the next step will then be the change in forward guidance as it relates to the timing of interest rate hikes. The current language used by the Fed is that rates will stay near zero for “a considerable time after the asset purchase program ends”. We think the Fed will alter this language at the October meeting removing “considerable time” from the statement. This will ultimately lead to the Fed raising interest rates starting in 2015 followed by the end of reinvestment of maturing securities. The Fed is not hiking rates now as the risks of tightening too soon are higher than the risks of tightening too late. Concerns about the fragility of the economy are already embedded in the policy outlook.
As mentioned previously, these announcements are in line with our expectations and continue to show that the FOMC supports a patient and gradual policy stance. This should continue to be supportive for the markets especially in the near term. We expect markets to stay in this slow growth, low inflation Fed supportive environment for at least another 6 months and believe the S&P 500 will likely cross the 2,000 level driven by accelerating growth and decent earnings. That being said, we are in favor of becoming more defensive in portfolios as we cross those levels and move closer to the inevitable Fed exit.
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