Stock, Treasury ETFs Look to ‘Taper Lite’

U.S. equity and Treasury ETFs rallied to start the week after Larry Summers dropped out of the running to replace Ben Bernanke as Federal Reserve chairman.

However, stock and bond ETFs should be volatile this week as investors look ahead to the Federal Reserve two-day policy meeting, followed by the announcement on Wednesday. [Bond Bulls Could Roar on Summers Withdrawal]

“This week, investors will be fixated on the September Fed meeting and whether (and to what degree) they taper their bond-buying activity at the end of their two-day meeting on Wednesday. The current consensus among most economists polled by Reuters is for the Fed to reduce its monthly bond purchases by $10 billion to $75 billion: a ‘taper-lite scenario,” PiperJaffray said in a note Monday. [ETF Investors Bet On ‘Taper Lite’]

“We believe global markets have risen over the past several weeks on a combination of improving economic data in the U.S. and anticipation of a taper-lite announcement at September’s Fed meeting,” it said. “Additionally, a taper-lite announcement would provide enough stimulus to keep equity markets happy while also ensuring the benchmark 10-year bond yield does not rise too quickly. In our opinion, the Fed will do nothing to disrupt this equity bull market and they will not be quick to pull away the proverbial punch bowl and risk the economy slipping back into a recession.” [iShares: Get Ready for ‘Taper Lite’ as Labor Market Isn’t Picking Up]

Yields on 10-year Treasury notes dropped below 2.8% Monday on the Summers news after touching 3% earlier this month. The iShares 20+ Year Treasury Bond ETF (TLT) gained 0.7% at last check. Bond prices and yields move in opposite directions.

In U.S. stocks, SPDR S&P 500 ETF (SPY) climbed 0.8%.

“Turning to this week’s Fed deliberations, FOMC members will likely recognize that the global economy has gathered momentum in recent months and that there have been no major economic disruptions in the United States,” said David Kelly, chief global strategist at J.P. Morgan Funds.

“Consequently, the Fed is likely to commence the reduction in bond purchases signaled by Mr. Bernanke after the Fed’s June 19th meeting. A lot of attention will be paid to the first move. The current pace of bond purchases is $85 billion per month and markets may react to whether the first step down is to $80 billion, $75 billion or $70 billion,” Kelly wrote in a weekly outlook. “Investors will also be looking closely at the Federal Reserve’s projections for the economy and the federal funds rate through 2016. The language used by Mr. Bernanke will also be important in the short run as he tries to convince markets that QE tapering isn’t the same as monetary tightening.”

Full disclosure: Tom Lydon’s clients own SPY and TLT.

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