The Fed taper: Reasons for comfort

Investors can still expect a period of low interest rates and treasury yields

IF YOU’RE a sports fan, June is a terrific month. The US Open Golf gets underway this week, with Tiger Woods still searching for his first Major since 2008, The Lions are touring Down-Under, and there’s Ascot and the British Grand Prix to come. But for global stocks, June has recently been a little less welcome.

Since 2000, this mid-year month has been tied with September as the worst performer for the Dow, with an average loss of 1.75 per cent. For the S&P 500, it’s the second worst month – with an average loss of 1.4 per cent.

So far this year, June has also been pretty volatile. Much of that is due to investors agonising over what the Federal Reserve will or won’t do – and more importantly when it will or will not act – with regards to its monthly $85bn asset purchases. In that sense, the latest US employment report clarified everything or nothing at all, depending on where you sit.

The headline number was a little stronger than expected, but below the 200,000 mark that suggests strong momentum. The unemployment rate rose because the labour force increased, but there was some weakness in manufacturing and a negative tone in hospitality.

The correct assumption would be that the US economy will continue its slow and modest recovery. For markets, this means not enough to change Fed policy or accelerate tapering off its bond purchases. It’s also not enough to delay a change in Fed policy. So stick to your poison. If you thought tapering would begin in September, then you should still hold that view. If you thought tapering would begin at the end of the year, then you should probably hold that view too.

Let’s hope what it does mean is that we can get away from good economic data being bad for stocks because of the fear of being weaned off an intravenous drip of liquidity.

But there are some reasons to be comforted. Whatever happens, investors can still count on a period of very low interest rates and treasury yields. As Capital Economics points out, it’s the stock of assets that the Fed holds which has a greater influence on yields than the flow, therefore “a reduction in the pace of the monthly asset purchases shouldn’t push yields much higher”. If one then adds a more subdued outlook for inflation, both stock and bond markets should take heart from a Fed that will be able to keep policy loose, even after QE3 has ended and the recovery is sustainable and strong.

There may be more volatility ahead and a degree of caution is called for. Stocks are still well up for the year despite recent pullbacks. But right now it may be that investors’ worst fears are fear itself.

Ross Westgate co-present’s CNBC’s Worldwide Exchange. Follow Ross on Twitter @rosswestgate