Stocks, bonds in rally mode ahead of Fed meeting on rates

Five years’ worth of record-setting quantitative easing has left the financial markets more anxious than usual about what the next move might be from the Federal Reserve Board.
A strong rally by the equity markets to start the week reflects a general sense that Fed Chairman Ben S. Bernanke will keep his comments as generic as possible during a press conference tomorrow afternoon, when he will unveil the Fed’s quarterly economic forecasts.
“I think the Fed will put it out there that they are continuing to monitor the situation and that they are planning to leave rates low for an extended period of time,” said Stephen Rosen, managing director at HighTower Advisors LLC.
The markets essentially are anticipating a much more muted version of Mr. Bernanke’s May public comments, in which he suggested the Fed might consider tapering its $85 billion monthly pace of bond purchases.
“The market has really taken to pricing in the risks that the Fed would start tapering in June or July, and we think the market got a little ahead of itself,” said Steve Van Order, fixed-income strategist at Calvert Investments Inc.
There is little doubt that the market is nervously trying to anticipate the Fed’s next move.
Even without a single adjustment to interest rates or the quantitative-easing policy by the Fed, the yield to maturity on the 10-year Treasury bond has spiked 8% since May 3 when it was at 1.63%
The yield on the 10-year has been hovering above 2.1% since May 28.
“Right now, the market is looking for clues, and you’ll probably see some form of rally in the bond market because we’ve had a huge sell-off in the past few weeks,” Mr. Rosen said. “I think we’ll see the yield on the 10-year go down a bit.”
The recent market volatility underscores the delicate balance the Fed is trying to maintain as it manages the reality the quantitative easing can’t last forever and that the unwinding process has to be as deliberate as possible.
“If there’s one thing Bernanke has learned, it is that you can’t go from zero to 60 in a tightening move,” said Dan Heckman, senior fixed-income strategist at The Private Client Reserve of U.S. Bank.
“I think the Fed is trying to convey to the market that the tapering will occur over a period of time,” Mr. Heckman said. “The market has correctly anticipated that this is the seventh or eighth inning of the quantitative-easing program, but we think the market is wrong in that we think the tapering will extend over a period from 18 months to two years.”
Although Mr. Heckman expects the Fed’s comments tomorrow to be “cautious and benign,” he also expects to see tapering start as soon as later this year.
“The markets generally move ahead of official announcements, and the market is already anticipating the tapering,” he said. “Candidly, I don’t think the Fed wants to see much more of a market reaction, because even though they are supposed to be independent, the federal government has $16 trillion worth of debt, and they can ill afford to have rates ratchet upward.”