U.S. stocks retreated as the Federal Reserve said risks to the economy have decreased, spurring concern the central bank will reduce its stimulus efforts.
The Standard & Poor’s 500 Index lost 0.4 percent to 1,644.63 at 2:04 p.m. in New York even as the Fed said it will keep buying bonds at a pace of $85 billion a month.
Risks to the outlook for the economy and the labor market have “diminished since the fall,” the Federal Open Market Committee said today at the conclusion of a two-day meeting in Washington. It repeated that it’s prepared to increase or reduce the pace of purchases depending on the outlook for the job market and inflation.
The Fed’s record low interest rates and bond purchases have helped fuel a rally in stocks that lifted the S&P 500 as much as 147 percent from its bear-market low in 2009.
The quantitative easing program suppressed interest rates, with the yield on the 10-year Treasury note reaching a record low of 1.39 percent in July and remaining below the S&P 500’s dividend yield for most of 2012 and 2013. The benchmark note’s average rate over the past year has been 1.78 percent, compared with an average of more than 6.5 percent in Bloomberg data starting in 1962.
The S&P 500 last set a record of 1,669.16 on May 21, the day before Fed Chairman Bernanke told Congress the central bank could begin to reduce the pace of asset purchases if the job market shows signs of sustainable improvement. Ten-year Treasury yields topped 2 percent that day for the first time since March.
The lowest rate of inflation since the brink of the Kennedy-era economic boom in the 1960s bought time for the Fed to press on with the central bank’s $85 billion in monthly bond purchases.
A gauge of consumer prices excluding food and energy that is watched by the Fed rose 1.1 percent in the year through April, matching the smallest gain since records started in 1960. With inflation below the Fed’s 2 percent long-run goal and the jobless rate at 7.6 percent, the Fed is falling short of its mandate to ensure stable prices and maximum employment.
The Fed will probably wait to taper bond buying until its Oct. 29-30 meeting, when it will cut its monthly purchases to $65 billion, according to the median estimate in a June 4-5 Bloomberg survey of 59 economists. By then, inflation will be rising toward the Fed’s target, accelerating to 1.3 percent in the third quarter and 1.5 percent in the fourth quarter, according to economists’ estimates.
While the end of Fed stimulus has preceded stock gains over the past two decades, those rallies usually followed periods of market weakness. The S&P 500’s 87 percent advance since the rate on overnight loans between banks was pushed to zero in December 2008 is more than five times the average advance in periods following monetary easing, data compiled by Bloomberg show.
The S&P 500, down 1 percent through yesterday from its May 21 record, has increased an average of 16 percent over two years the last four times the central bank started raising interest rates, according to data compiled by Bloomberg. Stock market volatility has been higher this year than during past periods when the Fed reversed policy. Daily moves for the S&P 500 have averaged almost 0.7 percent since March, compared with 0.44 percent in the month before the Fed tightened in 1994 and 2004.
U.S. stock investors may reap unusually high returns during the next five years thanks to interest rates on government bonds, according to a May 8 report from the Fed Bank of New York. Equities are inexpensive compared to government debt, according to the so-called Fed Model, which compares the earnings yield for stocks with Treasury rates. The valuation measure was derived from a July 1997 report from the central bank.
Per-share profit of $102.37 for all S&P 500 companies represents 6.2 percent of the index’s price level, or 4 percentage points more than yields on 10-year Treasury notes, according to Fed Model data compiled by Bloomberg. That compares with an average spread of 0.21 percentage points since 1990.
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