Tuesday, May 21, 2013
With nothing major on the economic calendar, stocks will likely remain in a tentative mood ahead of the Wednesday release of the last Fed meeting minutes and the Bernanke testimony before Congress. The key question for investors is to figure out whether the Fed is getting closer to announcing changes to its bond purchase program, which has been a key driver of the stock market rally.
Earnings reports from Home Depot (HD), Best Buy (BBY), AutoZone (AZO) and other will also be in focus in today’s session. Beyond the common thread of all three coming ahead of earnings expectations, there is not much in common among them. Home Depot appears to be firing on all cylinders, with the retailer’s housing leverage showing up in strong same-store sales (comps) growth and raised guidance. Best Buy came short on revenues, with margins and comps under pressure as it struggles with the 'show-rooming' phenomenon. AutoZone barely met revenue expectations as comps appeared weaker.
With respect to the Fed, the market has been paying special attention to all Fed speakers to foretell the central bank’s evolving view on the QE question. Last month’s FOMC minutes seemed to indicate growing momentum on the committee for changes to the bond purchase program. And we will likely see something similar in tomorrow’s minutes as well. We will know more from tomorrow’s Bernanke testimony as well, but I am increasingly of the view that we will see the announcement of changes to the program in the June FOMC meeting. Unless the May non-farm payroll report coming out on June 7th turns out to be unusually weak, I expect the decision to pare back the size of bond purchases to come out of the June 19th FOMC meeting.
The decision will reflect the need to synchronize the size of bond purchases with the expected lower amount of bond issuance later this year. Relatively better economic growth, higher taxes and somewhat lower spending levels have started eating into the trillion dollar deficits that the U.S. Treasury needed to fund through a boatload of bond issuances. As a result, the Congressional Budget Office now expects this year’s deficit to be $200 billion lower than their estimate of three months back. It is reasonable to expect the Treasury to issue fewer bonds in the coming months compared to the last few years.
If the Fed were to continue buying bonds at the same monthly rate, they would effectively be expanding the QE program. Bottom line, they need to taper the size of their bond purchases just to be in-line with the level of monetary stimulus they have been providing under the existing QE program. And my sense is that the announcement for this change will come in the June 19th FOMC meeting.
This will likely be the beginning of the end for the QE program, though it will take a very long time to fully unwind the enormous expansion that the Fed's balance sheet has endured over the last few years. The Fed will likely never sell any bonds on its balance sheet – they can simply decide against replacing maturing instruments. It is not a bad development for the economy, as it would signify the Fed's confidence in the economy's ability to operate on its own. It will, however, have negative consequences for the stock market, accustomed as it is to plentiful liquidity and rock-bottom interest rates.
Sheraz Mian
Director of Research
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