5 Stages of Federal Reserve Grief

Pessimists will underscore that there are still 11.8 million Americans out of work and the quality of many of the jobs was weak, with 75,000 new positions coming from low paying jobs in the leisure and hospitality industry. As far as the rate holding steady, pessimists note that a slew of part-time workers (360,000), many of whom would likely prefer full-time employment, boosted the workforce. As a result, the broad unemployment rate (unemployed, disgruntled and part time workers who would prefer full-time) jumped from 13.8 percent to 14.3 percent in June.

On a low-volume day, the optimists won the day, interpreting the report as proof that the economy was improving, but not by so much that the Fed would alter policy before its September meeting. Stocks gained ground, but the bond market was less convinced as 10-year treasury prices slumped and yields increased to 2.72 percent, the highest level in almost two years.

Is this what the rest of the year is going to be like? Since May 22nd, after Fed Chairman Ben Bernanke testified before Congress and raised the prospect that the central bank could downshift from its accommodative policies if economic data were to improve, investors have been throwing a “Taper Tizzy.” Every day is highlighted by the question, “When and by how much will the central bank taper its bond buying?”

This week, the Fed-funk is likely to continue, after the release of the minutes from the last policy meeting. You might recall that was the meeting after which Chairman Ben Bernanke attempted to soothe investors with more details about the conditions under which the Fed would take its foot off the gas. Instead of the intended calming effect, Bernanke inflamed the situation and volatility spiked across all asset classes.

Taking the Fed at its word, we know that the exit strategy is a work in progress, which will be driven by economic data. Capital Economics sees five stages of the Fed’s exit plans. From an investor perspective, these stages might seem to match Elisabeth Kübler-Ross’ “Five Stages of Grief”:

(1) Taper monthly asset purchases this fall (DENIAL)

(2) End bond purchases completely by mid-year 2014 (ANGER)

(3) Modify forward guidance language included in FOMC policy statement (BARGAINING)

(4) Raise short-term interest rates in 2015 (DEPRESSION)

(5) Begin to sell Fed’s holdings of Treasuries starting in 2017 (ACCEPTANCE)

Regardless of the exact timing and staging, these steps will occur and the quicker investors adapt and accept them, the better off they will be.

For those who were getting sick and tired of the constant Federal Reserve naval-gazing, there is something new to agitate raw nerves: geopolitical risk. In the two years since the Arab Spring, there hasn’t been much discussion of geopolitical risk, which is loosely defined as the risk that an investment’s returns could suffer as a result of instability in a country, due to a change in government, legislative bodies, other foreign policy makers, or military control. The situation in Egypt has all of the components necessary to qualify and has already pushed up crude oil prices — NYMEX crude breached $100 per barrel for the first time in over a year. Thankfully, those increases have not translated to higher prices at the pump yet.

As a reminder, Egypt is not a major oil producer and has been a net oil consumer of oil since 2008. However, its control of the Suez Canal and its proximity to large Middle East oil exporters puts investors on alert whenever there is political unrest. Approximately 2.5 million of barrels of crude oil pass through the Suez Canal or the Suez-Mediterranean(SUMED) pipeline each day. Any disruption to the flow of oil could have ripple effects throughout the region.

Markets: In a holiday-shortened week, stocks benefited from a surprise announcement from across the pond. For the first time, both the Bank of England and the European Central Bank provided investors with forward guidance. Both central banks will maintain their aggressive policies for an extended period.

• DJIA: 15,135, up 1.5% on week, up 15.5% on year
• S&P 500: 1631, up 1.6% on week, up 14.4% on year
• NASDAQ: 3479, up 2.2% on week, up 15.2% on year
• 10-Year Treasury yield: 2.72% (from 2.49% a week ago, yield now at 23-month high)
• Aug Crude Oil: $103.22, up 6.9% on week
• August Gold: $1212.70, down 0.9% on week
• AAA Nat’l average price for gallon of regular Gas: $3.47

THE WEEK AHEAD: Q2 earnings season kicks off this week. S&P Capital IQ predicts earnings to increase by 2.9 percent from the same period a year ago and for the full year to rise by 6.3 percent from 2012.

Mon 7/8:

Alcoa

3:00 Consumer Credit

Tues 7/9:

7:30 NFIB Small Business Optimism Index

Weds 7/10:

2:00 FOMC Minutes

4:10 Ben Bernanke delivers speech

Thurs 7/11

Bank of Japan rate decision

8:30 Weekly Jobless Claims

8:30 Import/Export Prices

Fri 7/12:

JP Morgan Chase, Wells Fargo

8:30 Producer Price Index

9:55 Consumer Sentiment

For more, go to JillonMoney.com

Image by Flickr User by Subtleness