Stock exchange traded funds were deep in the red Monday and could see more big swings this week as the Federal Reserve meets and investors look for further easing from the central bank.
Expectations of some type of policy announcement on Wednesday have been running high since Fed Chairman Ben Bernanke last month said the Fed will take an extra day at its September meeting to consider additional support for the economy. [Stock, Gold ETFs Rally After Bernanke]
The central bank has also promised to keep short-term interest rates near zero until at least mid-2013.
So what additional steps might the Fed take as economic data weakens?
“Of the remaining options, it seems unlikely that the Fed will further expand the overall size of its balance sheet, in what would be known as QE3,” said David Kelly, chief market strategist at JP Morgan Funds. “The Fed already has $2.9 trillion in assets, three times its holdings of three years ago and faces a long and complicated process in eventually returning them to normal.”
Treasury ETFs rallied Monday as stocks and bond yields fell on concerns over a possible Greek default. The iShares Barclays 20+ Year Treasury Bond (NYSEArca: TLT) jumped 2.6% to a new 52-week high. Yields on the 10-year note fell back under 2%.
“There is a greater chance of the Fed implementing what is known as ‘Operation Twist ‘(named after a maneuver first used in the early 1960’s) by which it would sell short-term government bills and buy long-term government bonds in an attempt reduce long-term Treasury rates,” Kelly wrote in a weekly outlook. “However, with real long-term interest rates already at their lowest levels in decades, it is hard to argue that anyone is hesitating to borrow money today because rates are ‘just too high,’ and thus hard to see how this could stimulate the economy.”
If the Fed disappoints and doesn’t announce any stimulus, stock ETFs could take a hit this week. There are also worries that the central bank may be pushing on a string.
“Another possibility is that the Fed could cut the interest it pays banks on reserves held at the Federal Reserve, thus encouraging them to increase lending. However, since the rate on reserves is just 0.25% today, it’s unlikely that such a reduction would cause a huge change in bank behavior,” the JP Morgan Funds strategist added. “The truth is that the economy is suffering from a lack of confidence rather than a lack of liquidity and ever-more-desperate attempts by the Fed to increase the latter are undermining the former.”
iShares Barclays 20+ Year Treasury Bond
