The S&P 500 (INDEXSP:.INX) has lost more than 2% of its value in the last five days of trading and continued its losses on Monday. The reason for the losses, according to an analysis which appeared in the Financial Times earlier today, is the expectation among investors that the Federal Reserve will begin tapering off quantitative easing.
Recent economic data suggests that the United States economy is recovering, a trend which may see the Federal Reserve reduce the magnitude of the QE program in line with recent comments from its chairman Ben Bernanke. The expectations of the market, according to bond yield at least, is that the program will be lessened, and that is depressing equities.
Bond yield high, emerging markets pressured
10 year US Treasury bond yields increased 5 basis points on Monday to hit a new two year high of 2.88%. The same magnitude of addition was seen in equivalent bonds from the United Kingdom; while German bonds were also up, albeit by a smaller margin. A report from Societe Gernerale predicts that 10 year Treasury yield will hit 3.25% by the end of the year, while yields on the equivalent German bonds are likely to end the year with yields above 2%.
The increase in yields gives some respite to fixed income investors, but it could be bad for the equities market, and for the global economy as a whole. The pressure has already been seen in emerging markets. The wide iShares MSCI Emerging Markets Indx (ETF) (NYSEARCA:EEM) is down more than 1.82% on today’s market.
Mortgages feeling pressure as equities get targeted
The increase in interest rates is causing pressure in the mortgage market where applications are down for new homes and refinancing. If bond rates continue to rise there may be a depressing effect on the entire world economy, as capital becomes more expensive and investment moves to debt from equities.
The Federal Reserve has been non-committal on its plans to taper quantitative easing. The bank has said that if tapering doesn’t work it will consider boosting the program back up again. The lack of certainty on the central banks plans for the program could be the cause for a great deal of volatility in the months and weeks ahead.
The Fed will release the minutes of its most recent Open Market Meeting, held in July, on Wednesday. Analysts and investors will be studying the minutes for clues about the intentions of the banks as Ben Bernanke heads toward the end of his term as the bank’s chairman.