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How ‘taper’ became a four-letter word

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By the time the music stopped on Friday, the S&P 500 was down by more than 2 per cent.

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True, markets have been volatile for several weeks, but lost faith in earnest this week after Federal Reserve chairman Ben Bernanke laid out a possible timeline for the central bank's pullback from its quantitative easing program.

Known as QE, that's an asset-buying scheme worth $85-billion (U.S.) a month aimed at keeping interest rates down.

Stocks began plunging, and bond yields spiking, when Mr. Bernanke said Wednesday that the Fed will probably begin pulling back, or tapering, later this year. Observers believe the world's most powerful central bank will begin to taper in the fall, possibly cutting back to $65-billion, and end the extraordinary program completely next year.

That doesn't mean hiking the benchmark rate, now effectively at zero with a pledge to keep it there until unemployment eases to 6.5 per cent.

"We look for the Fed to begin slowing QE in the autumn and stopping QE in the spring," said senior economist Michael Gregory of BMO Nesbitt Burns.

"The latter point will still be well beyond a year before the Fed starts tightening, which may provide little comfort for the bond market for the next while."

Investors don't want QE to end before the economy and the markets can handle it.

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Some observers believe the market reaction to Mr. Bernanke was knee-jerk and over the top, given that investors knew, or should have known, that an end was in sight for this, the third round of quantitative easing, dubbed QE3.

Behind this is a brighter outlook for the U.S. economy, and that's not new. Add to that the fact that, if the program scales back as expected, the benchmark rate will remain at its emergency low.

"The bottom line is that the selloffs, particularly in the bond markets, appear overdone," said economist Michael Dolega of Toronto-Dominion Bank.

"Tapering is not tightening," he said in a research note Friday.

"The Fed funds rate will likely stay effectively at zero until 2015. Even assuming $10-billion per month of tapering, the Fed will still buy another $650-billion worth of assets by the time the program is done. That's more than the whole of QE2."

He makes a good point: Any pullback will come amid stronger economic activity, which the QE program was meant to spark.

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"Perhaps we forgot and need to remind ourselves that we really can't have our cake and eat it, too," Mr. Dolega said.

The markets certainly don't feel that way, though they had the added worry over the latest economic signals from China.

Put it all together, and the S&P 500 suffered its most troubling week since November.

"Meantime, the TSX fell 1.6 per cent on the week and, sadly, sits barely above levels seen at the end of 2009," said senior economist Robert Kavcic of BMO Nesbitt Burns.

"While current valuations argue for a choppy summer, the medium-term environment should ultimately remain equity friendly," Mr. Kavicic sadded.

"With all the concern about the tapering and eventual end of QE, keep in mind that since 1981, the period when the Fed was on hold after easing, has been as strong as it gets for stocks, with the S&P 500 posting annualized returns of more than 15 per cent on a monthly average basis during these periods."

As a "bonus," Mr. Kavcic added, the Fed promised to hold the benchmark rate steady for some time after QE ends and while the economy recovers, a suggestion that "this sweep spot of the Fed policy cycle for stocks could run longer than normal this time around."

Required reading
Canada needs to better protect intellectual property, chiefly with longer patent protection, so Canada is on par with Europe and the United States, says the Canadian CEO of French drug giant Sanofi. Read Sophie Cousineau's interview with Christopher Viehbacher.

Brookfield Asset Management Inc. struck two deals to sell forestry assets for $3.68-billion (U.S.), making moves that underscore a long-awaited recovery in North America's forest products market, Brent Jang reports.

Embraer SA, a fierce competitor against Bombardier in the market for regional jets, is upgrading its fleet and taking aim at Bombardier's $3.4-billion C Series, Greg Keenan writes.

Enbridge Inc. rejected the national energy regulator's demand to have almost $1-billion in liability coverage set aside for the Northern Gateway project, and is calling for the creation of an industry-bankrolled fund that would help pay for cleanup in the case of "a catastrophic oil release" from a Canadian pipeline, Kelly Cryderman reports.

The myth of perfectly secure communication is dying. Read Omar El Akkad's look at the world of snooping.

Hudson's Bay Co. announced moves to replacing its star president, Bonnie Brooks, with a company veteran in a surprise that spooked investors, Marina Strauss and Bertrand Marotte report.

Canada's rich have never been richer, with those in the highest wealth bracket seeing the fastest growth. Tavia Grant reports.

Wind Mobile's foreign backers abandoned their eight-month bid to formalize control over the company, casting a pall over the future of Canada's largest independent wireless carrier, Rita Trichur, Steven Chase and Boyd Erman report.

Exxon Mobil Corp. jumped into the race to export liquefied natural gas from Canada's west coast to Asia, with a huge proposal to process 30 million tonnes per year in Kitimat and Prince Rupert, Shawn McCarthy reports.

Maple Leaf Foods Inc. has emerged as a potential takeover target in the rapidly consolidating global food sector, Jacquie McNish writes.

The week in Business Briefing

The week in Streetwise (for subscribers)

The week in Economy Lab

The week in ROB Insight (for subscribers)

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About the Author
Report on Business News Editor

Michael Babad is a Report on Business editor and co-author of three business books. He has been with Report on Business for several years, and has also been a reporter and editor at The Toronto Star, The Financial Post and United Press International. His articles have appeared in major newspapers around the world. More


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