Download Can the Fed Fend Off the Ides of March?

Can the Fed Fend Off the Ides of March?
March 18, 2014
by Kristina Hooper
of Allianz Global Investors
Ahead of this week’s FOMC meeting, look for volatility to rise as tensions mount in Ukraine on the
heels of a controversial referendum. But investors should focus on fundamentals and avoid kneejerk
reactions to the evolving situation.
On Sunday, Crimeans voted overwhelmingly to secede from Ukraine and become part of Russia.
Meanwhile, Russian troops gathered at the Ukrainian border. Stocks fell substantially, volatility
increased significantly and the yield on the 10-year Treasury fell.
“Despite the conflict in Ukraine, we don’t expect the FOMC to alter its plans for tapering asset
purchases.”
March Madness
The Ides of March, March 15, is a significant date in history. It was the day that Julius Caesar was
assassinated in 44 BC. Caesar’s assassination was a critical turning point in Roman history, triggering
events that transformed the Roman Republic into the larger Roman Empire.
Yesterday, just as the Ides of March had passed, and just as expected, Crimea voted to join Russia.
Some pundits worried it would mark a turning point in Russian history, triggering events that could
transform Russia into a larger Eastern European Union and materially impact the balance of power.
Others believed it would be a repeat of Russia’s takeover of provinces in Georgia in 2008, an isolated
event that would have limited impact on international relations. Still others suspect it was a necessary
move for Russian President Vladimir Putin, who may feel increasingly threatened economically by the
European Monetary Union and militarily threatened by Russia’s southern neighbors with nuclear
capabilities.
For the stock market, this likely means a continuation of last week’s volatility. With Crimea’s decision
to separate from Ukraine, we expect a near-term rise in risk premia, or returns above Treasury yields
rewarded to investors who take on higher risk, but not necessarily a lasting destabilization of markets if
the West accepts this outcome.
However, the West is calling the vote “illegitimate and forced” because there was no option on the
ballot for Crimea to remain part of Ukraine. And the fact that Russia has begun to discuss concerns
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about the protection of ethnic Russians in other locations in Ukraine, raising the possibility of an
invasion in those regions, there’s a chance this situation could worsen and have a more lasting impact
on stability.
FOMC and Forward Guidance
Despite the conflict in Ukraine, we don’t expect the FOMC to alter its plans for tapering asset
purchases when it meets this week. While the Fed received an additional mandate from Dodd-Frank to
help ensure stability in the markets, it’s highly unlikely that the central bank would change its monetary
policy on account of a geopolitical crisis. In addition, while the vote in Crimea could be the start of more
uncertainty and perhaps even a reinvented Russian bloc, it’s unlikely to impact the investing landscape.
We would discourage investors from changing their allocations because of the situation in Ukraine. We
remain focused on fundamentals and encourage investors to do the same.
While we’ve seen some weakness in the US economy in the past few months, economic surprise
indices in March have risen, suggesting much of the downturn was weather-related. We believe the
Fed is unlikely to change its projections on when it will raise the fed funds rate.
Still, we expect the FOMC to continue to move to more qualitative and holistic guidance on its target
interest rate. Using the unemployment rate as an indicator of when to raise the target rate is flawed,
and that’s becoming increasingly obvious. The FOMC should benefit from stepping back and analyzing
the state of the labor market and the economy more fully.
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In short, we don’t expect any surprises when the FOMC meets this week. The Fed will surely
recognize the winter economic slowdown, but will likely continue on its current, highly accommodative
path. Expect looser for longer.
Kristina Hooper, CFP, CAIA, CIMA, ChFC, is US head of investment and client strategies for Allianz
Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in
finance from NYU, where she was a teaching fellow in macroeconomics.
Purchasing Managers’ Indexes (PMI) are economic indicators derived from monthly surveys of private
sector companies. The Chicago-PMI survey registers manufacturing and non-manufacturing activity in
the Chicago region. Investors care about this indicator because the Chicago region somewhat mirrors
the nation in its distribution of manufacturing and non-manufacturing activity.
Thomson Reuters/University of Michigan Surveys of Consumers is a consumer confidence index
published monthly by the University of Michigan and Thomson Reuters. The index is normalized to
have a value of 100 in December 1964. At least 500 telephone interviews are conducted each month
of a continental United States sample (Alaska and Hawaii are excluded). Five core questions are
asked.
The material contains the current opinions of the author, which are subject to change without notice.
Statements concerning financial market trends are based on current market conditions, which will
fluctuate. References to specific securities and issuers are for illustrative purposes only and are not
intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.
Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as
advice or interpreted as a recommendation.
Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for
the purchase or sale of any financial instrument. It is presented only to provide information on
investment strategies and opportunities.
A Word About Risk: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do
not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and
subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be
greater in emerging markets.
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AGI-2014-03-17-9190
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