How the Fed Pushed the Dow Higher

How the Fed Pushed the Dow Higher

The Federal Reserve announced just after 2 p.m. EDT that it would maintain its $85 billion-per-month asset purchase program, putting off the long-anticipated "tapering" of its quantitative easing until later this year. Recent unemployment data, rising mortgage rates, and government spending cuts have been reason enough for the Fed to decide that the economy can't yet stand on its own yet and that more stimulus is needed.

Economists were expecting a pullback of $10 billion to $20 billion per month, so the news was a bit of a surprise. Stock investors cheered the Fed's decision by pushing the Dow JonesIndustrial Average 0.97% higher and the S&P 500 1.2% higher late in trading.

The Fed's impact on interest rates
The continuation of the bond-buying program means that long-term interest rates, which have risen sharply since May, will continue to be held lower. As an example of the impact, the 10-year Treasury yield has already fallen 10 basis points (0.1%) today to 2.76%. This is the key rate that drives mortgage rates, and it has spiked as high as 3% this month after hovering below 2% since mid-2012.

The bad news for long-term investors is that the Fed is seeing a weaker economy than it had hoped for. The 2013 GDP growth forecast was lowered to a range of 2% to 2.3% from a previous estimate of 2.3% to 2.8%, which won't be good for companies' revenue growth this year.

A little perspective on a wild day
It's always important to put moves like today's into perspective. What investors are cheering in the short term is that the Fed will keep monetary stimulus in place, keeping interest rates low. But the reason the Fed is helping push rates lower is that the economy still needs the crutch of stimulus.

In the long term, investors should prefer higher GDP growth to monetary stimulus that will eventually have to be pulled back. I wouldn't buy stocks today based on the Fed's "tapering" decision, but I would consider the revised GDP estimate. That will have more impact on company fundamentals than a few more months of stimulus, and fundamentals will drive the long-term value of stocks.

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