As Fed bond buying ends, uncertainties may emerge

BOSTON - Expect investing to get more uncertain starting next month and potentially less rewarding.

That's the warning from pros who are preparing for slightly more volatile markets when the government's latest government stimulus program ends. Thursday will be the last day of a Federal Reserve program dubbed QE2, short for quantitative easing, round two.

The first such bond-buying program began in March 2009, when the stock market bottomed out near the end of the Great Recession. In the second round, begun last November, the Fed bought $600 billion in Treasury bonds.

Now, the biggest buyer of those government IOUs will play a new role: Eventually, it will sell those bonds back to the market.

Investors have anticipated that shift for months. Yet the program's end is making some money managers more cautious because of the greater uncertainty it creates.

The Fed expanded the pool of buyers for Treasuries by purchasing around $75 billion of the bonds each month, starting in November. The purchases helped reduce Treasury yields, making them unappealing for any investor seeking a decent return. Yields for 10-year Treasuries, for example, have recently slipped below 3 percent. This has helped prompt investors to seek out other assets, such as stocks and higher-yielding corporate bonds, whose prices have rallied since the recession.

"QE2 has been a pretty big source of demand for riskier assets, and with that going away, that's one of the reasons we're cautious now," said Mike Buckius, co-manager of the Gateway Fund, a $5 billion stock mutual fund.

Here are some key trends money managers expect in coming months as the effects of QE2 wear off:

Stocks

The stock market is all about expectations, and prices generally move months before anticipated developments in the economy actually play out.

It's been known for months that QE2 would cease on Thursday, so the market has likely priced in the program's end. Many think that's a key reason stocks declined six straight weeks starting in May, in addition to factors such as growing worries about Greece's debt crisis.

"Are we going to have a big market meltdown on June 30 because that is the day QE2 ends? No," said Kent Croft, co-manager of Croft Value, a $404 million stock mutual fund.

Without QE2, it is likely stock prices would not be as high as they are today, said Bob Doll, chief stock strategist with asset manager BlackRock Inc.

"However, this does not mean that when QE2 ends, stock prices will go down," he said. "It merely means there will be one less positive tailwind for the markets."

Bonds

Marilyn Cohen, a manager of $325 million in bond portfolios for clients of Los Angeles-based Envision Capital Management, said the end of the Fed's Treasury purchases should eventually drive up yields. Other investors may be unwilling to buy Treasuries at their currently low yields, unless prices for stocks fall, driving investors into the perceived safety of government debt.

Cohen will closely watch Treasury auctions to see whether adequate demand exists to keep yields low. She expects volatility, as investors assess a new Treasury market without the Fed as a buyer.

"It will take multiple auctions before we know who the natural buyers of Treasuries will be, since the unnatural buyers (the Fed) will be stepping aside," Cohen said. "All you need is two lousy back-to-back Treasury auctions, and then it will be, 'Look out, below.' "

Economy

Many economists credit QE2 for heading off the threat of deflation - a destabilizing drop in wages, the prices of goods and services, and the value of stocks, homes and other assets.

However, critics fear QE2 and other stimulus programs have increased chances of long-term inflation. That hasn't happened yet, although there was a rise in oil and gas prices early this spring, a factor that helped trigger the recent slowdown in the economic recovery. Prices have recently slipped below $4 a gallon, but remain high, with the current national average at $3.60.

by Mark Jewell Associated Press Jun. 26, 2011 12:00 AM




As Fed bond buying ends, uncertainties may emerge