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It's clear from the leaked Federal Open Market Committee (FOMC) meeting minutes that the Fed isn't taking away the punchbowl quite yet - but investors can take steps now to be prepared for an eventual sign that quantitative easing will end.
The FOMC meeting minutes show the central bank remains divided on when to end QE and raise interest rates.
The Fed's current policy of buying $45 billion in Treasuries and $40 billion in mortgage-backed securities monthly will remain in place at least through midyear. Near-zero interest rates also look safe until 2015.
The Fed has held short-term rates at historic lows since 2008, with a goal of juicing the anemic U.S. economy. The Fed minutes reiterated that Bernanke and company will keep rates super low until the unemployment rate dips below 6.5% or inflation rises above 2.5% a year.
The monthly March jobs report, released after the March 19-20 Fed meeting, showed a significant slowdown in job creation. While the unemployment rate ticked down to 7.6% from 7.7%, the rate decreased largely because a huge number of people stopped looking for work.
The glum employment data could even extend the Fed's 2015 date to raise interest rates.
Some FOMC members, including San Francisco Fed President John Williams and Kansas City Fed President Esther George, favor winding down the $85 billion-a-month asset purchases. They point to inflation and excessive economic risk-taking.
Yet the majority of committee members see no need to taper off the buying until at least Q3 of 2013 or 2014.
According to the minutes, "A few members felt that the risks and costs of purchases, along with the improved outlook since last fall, would likely make a reduction in the pace of purchases appropriate around midyear with purchases ending later this year. Several others thought that if the outlook for the labor market conditions improved as anticipated, it would probably be appropriate to slow purchases later in the year and to stop them by year-end."
Despite the dissent, a lack of encouraging economic data will support continuing QE measures.
Atlanta Fed President Dennis Lockhart said on CNBC, "I think we need a few more months of really solid data and solid evidence that the recovery is moving ahead" before the Fed pulls back.
How to Prepare for the Fed's Exit
The Fed's easing measures have been credited for propelling the Dow Jones Industrial Average and the S&P 500 Index into record territories.
But when the Fed does turn off the spigot, or reduces it to a trickle, the outcome could be painful.
Here's what investors should be prepared to do:
- Avoid High-Yield ETFs: Even if the Fed is graceful in its exit, market reaction will not be as refined. The result could be a sharp selloff in high-yield ETFs.
- Sell Momentum Stocks: Stocks that move on momentum are great while the energy lasts, but when the wind behind the sails stalls, the outcome is never pretty.
- Buy Insurance: Protect a portfolio using puts on the SPDR S&P 500 ETF Trust (NYSE: SPY) or calls on the iPath S&P 500 VIX Short-Term Futures (NYSE: VXX).
Look for more clarity following the Fed's next FOMC meeting, which concludes May 1.
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