“Is ‘Forward Guidance’ a crotchet to which exaggerated importance is attributed?” Richard Fisher asked ahead of his speech at the London School of Economics (or LSE) on Monday, March 24. “Have we at the (Fed) just taken up another fad? Or is this a real, lasting practice?” Fisher was referring to the Fed’s decision to provide qualitative rather than quantitative guidance in future FOMC statements.
The Fed’s tapering of monthly asset purchases is expected to end this fall. Markets are closely watching for developments on the Fed front as to when the base rate might rise. At the end of the recently concluded FOMC, indications suggested the rate would rise between Q2 and Q4 2015. The Fed funds rate, or the base rate, has been between 0% and 0.25% since December 2008. “What we are trying to do now is to articulate the best we can what happens after our massive QE… Basically what we have done, is we have de-quantified our guidance. And are seeking to provide qualitative indicators of how we might proceed,” Fisher said at the LSE.
Fisher also said that while central banks would try to provide as much detail as possible, markets shouldn’t expect specific quantitative guidance without mistakes, which would then put reputations at risk because forecasts changed due to changing conditions. “By its very nature qualitative guidance will be a little bit sloppy. We are looking at a new approach… How to communicate the end of asset purchases?”
Richard Fisher has been President of the Federal Reserve Bank of Dallas since 2005. The Dallas Fed’s district includes Texas, northern Louisiana, and southern New Mexico. One of the most hawkish Federal Reserve Bank Presidents, Fisher wants to end the Fed’s monthly asset purchases as soon as possible. Fisher is part of this year’s FOMC, and he’ll vote on policy.
A change in the Fed funds rate would impact both stock markets and fixed income markets. Other things remaining constant, an increase in the Fed funds rate would imply that the economic growth is on track, which should boost stock market returns. One ETF with exposure to a broad-based index like the S&P 500 Index is the Vanguard S&P 500 ETF (VOO). The top ten holdings in VOO include Exxon Mobil Corp. (XOM).
Rate increases would also impact fixed income ETFs, as bond prices fall when rates increase. Investors can mitigate this interest rate risk by investing in floating-rate fixed income ETFs like the Market Vectors Investment Grade Floating Rate ETF (FLTR) and the SPDR Barclays Cap Investment Grade Floating Rate ETF (FLRN). Inverse bond funds like the ProShares Short 7-10 Year Treasury Fund (TBX) and the Barclays iPath US Treasury 10-Year Bear ETN (DTYS) are also a good option. Inverse bond ETFs provide the inverse return of the underlying benchmark index.
To read more about the Fed’s recent policy shift towards qualitative guidance, continue to Part 2 of this series.
© 2013 Market Realist, Inc.