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Bernanke to Markets: The Fed Can’t Do It All

Monday, 25 June 2012 04:40 PM Current | Bio | Archive

“Let’s Twist again, like we did last summer.”

That’s Ben Bernanke’s new tune. Last week, the Fed chairman announced that the central bank will implement a second round of the program designed to keep interest rates low.

But rather than helping, Twist 2 puts added pressure on the markets. The U.S. already faces a “fiscal cliff” at the end of the year. Unless Congress acts before then, the Bush tax cuts will expire, automatic spending adjustments will take place, and other measures will kick in to help balance the budget.

Many Fed watchers were expecting another round of quantitative easing instead. Unlike the Twist programs, which merely shuffle assets on the Fed’s balance sheet, QE adds to the Fed’s balance sheet.

This has the effect of sending stocks and commodities higher, while sending the dollar lower. Some reason that this creates a “wealth effect” whereby higher stock prices make people feel wealthier, and, thus, they go out and spend more.

Bernanke has repeatedly warned Congress that the Fed can’t do it all. Congress must act to put America’s fiscal imbalances back in order.

Now it appears that Bernanke is passing responsibility back to Congress. That’s to be expected. Up until now, Bernanke has acted while Congress has dithered. Indeed, Congress has no doubt been relieved that it has been able to pass the buck on to the Fed for so long.

The big question now for investors is: What happens at the end of the year?

If the Fed has no further actions that it’s willing to take when Twist 2 ends, interest rates may start to tick upward. In an age of phenomenal budget deficits, the only reason that the so-called vigilantes of the bond market haven’t stepped in to increase interest rates on U.S. Treasurys is because they really can’t. They’re not the key player in that market, the Fed is. Last year, the central bank bought over half of all new Treasurys issued. That could change if the Fed stops easing programs.

Without legislative changes, expect lower returns on your investments thanks to higher taxes on capital gains and dividends.

The biggest problem between now and the end of the year isn’t whether the economy gets better or not. The question is what, if anything, the Fed or Congress will do. Until there’s firm action, expect continued volatility as uncertainty to reign in the markets.

The best step for investors right now is to contribute cash to tax-deferred investment accounts like 401(k)s or IRAs. This ensures that, no matter what happens, there’s the opportunity to profit from the unexpected without having to deal with higher tax rates.

And, of course, hang on. It’s going to be a wild ride as markets start worrying about the end of the year. Now is the time to take profits on volatile positions and set a watch list of companies worth owning on a pullback.

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Monday, 25 June 2012 04:40 PM
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