| Dear Valued Client, Just three days following the fifth anniversary of the Lehman Brothers bankruptcy and the birth of the Financial Crisis, the Federal Reserve (Fed) remained firmly committed to keeping the full force of its easy monetary policy in place. On September 18, the Federal Open Market Committee (FOMC) of the Fed released its most anticipated statement of the year on monetary policy. But what was most profound was not what was said, but rather what was absent. The market's strong consensus was that the Fed would announce a reduction in its $85 billion per month in bond purchases, a program referred to as quantitative easing or QE. The reduction in QE, more commonly referred to as tapering, was anticipated to start in September at $10 billion (the Fed reducing asset purchases from $85 to $75 billion) and accelerate until the program completely unwound sometime in mid-2014. However, the Fed surprised the market by making no changes to its policy at all. Instead of Taper or even TaperLite, we got ZeroTaper. The news sent risk assets strongly higher as the S&P 500 and the Dow finished the day at all-time highs. Bond prices, which were hurt by the fear of an impending Fed taper (and thus the start of its unwinding of its easy monetary policy), rallied significantly, as the 10-year Treasury yield fell from 2.88% to 2.69%. So why did the Fed elect not to taper? Fed Chairman Ben Bernanke hinted at several reasons. First, the Fed is concerned about the fiscal battles in Congress over the continuing resolution to fund the government and increasing the debt ceiling, given that these events have been negative catalysts for the market and economy in recent years. In addition, the Fed worried that the U.S. economy is not accelerating fast enough and stands to grow at under 2% GDP (gross domestic product) rates, which is dangerously close to "stall" speed. Lastly, the rapid increase in bond yields, from as low as 1.6% in May 2013 to 3% a few days ago for 10-year US Treasuries, had the Fed concerned as these interest rates directly affect important consumer and business lending, including mortgage rates. In a sense, by not tapering, the Fed "smacked" the wrist of the market for driving yields of longer-term bonds and thus interest rates so much higher, so quickly. Remember that the Fed directly controls short-term interest rates through its federal funds rate target, but the market establishes long-term rates through its assessment of future economic growth and inflation expectations. The Fed was disappointed in the way the market took its hint of a taper and extrapolated it into an imminent full-scale exit from its easy monetary policy. After all, the market had moved yields up almost 100% (1.6% to 3.0%) in just a few months. As such, the Fed wanted to make sure that it got the market's full attention and used the surprise "silence" of no taper to reinforce that the Fed will maintain its low interest rate policy for an extended period. We see the Fed's decision to keep both feet on the easy monetary policy gas pedal as modestly bullish for equities, a risk to the dollar, and a platform to enable a small rebound for bonds. By forecasting inflation of 2% or less over the coming three years, the Fed signaled it may take longer than anticipated to ultimately raise rates or remove stimulus, both of which are bond-friendly over the intermediate term. This means the severe bond market sell-off we have experienced over the last few months is likely over for now, and that yields may hold in a relatively tight range for the remainder of the year. Despite the dovish actions of the Fed, we do have to remain mindful that risks persist. The debt ceiling debate begins in earnest and Middle East geopolitical concerns continue. And while the Fed decided not to taper now, it signaled that tapering is just around the corner. Because a Bernanke-led Fed introduced QE policy in the first place, it does make some sense that the Fed also starts its path toward exiting it before Bernanke leaves office in January 2014, rather than leaving the lingering uncertainty for a new Fed leadership. The end result is that the taper talk and market nervousness over it will re-emerge leading up to the next FOMC meetings in October and December. The Fed was all bark and no bite by postponing a reduction in bond purchases and clearly showed concern over rising interest rates and the potential impact on the economy. The Fed has itself in a bit of a bind as it wants to signal a gradual exit from easy monetary policy, but market expectations and slowly improving economic conditions continue to warrant perhaps a faster unwind. But for at least one meeting, the Fed made clear its intention to do whatever it takes to keep rates low and the economy improving. And it did so with the most powerful tool of all…silence. As always, if you have questions, I encourage you to contact me.
IMPORTANT INFORMATION The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult me prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The economic forecasts set forth in this letter may not develop as predicted. Yield is the income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment's cost, its current market value or its face value. Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate. Treasuries are marketable, fixed-interest U.S. government debt securities. Treasury bonds make interest payments semi-annually, and the income that holders receive is only taxed at the federal level. Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory. This research material has been prepared by LPL Financial. To the extent you ar receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity. Not FDIC/NCUA Insured | Not Bank/Credit Union Guaranteed | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit LPL Financial, Member FINRA/SIPC Tracking #1-202988 | (Exp. 09/14) | 
