The Fed Walks Backs Away From Being Calendar-Dependent

NEW YORK ( TheStreet) -- After Federal Reserve Chairman Ben Bernanke unintentionally stirred up a hornet's nest with his comments and disrupted financial markets, his lieutenants stepped in to attempt to allay worries.

Bernanke has been Fed chairman for seven years, yet he still hasn't learned how to communicate effectively with the markets.

Since Bernanke spoke, there has been a parade of Fed regional bank presidents, including James Bullard of St. Louis, Narayana Kocherlakota of Minneapolis and William Dudley of New York, attempting to publicly defuse Bernanke's trial balloon. Bernanke had said that Fed policy might become calendar-dependent and that the central bank might start slowing asset purchases later this year and end the program sometime in 2014.

If Bullard et al are giving a more accurate representation of the Reserve Board's thinking, then the asset purchase program, under which the Fed buys $85 billion of Treasuries and mortgage-backed securities each month, will go back to being data-dependent. That means policy will target a 6.5% unemployment rate and a 2% rate of inflation. For now, unemployment is more than 6.5% and inflation is less than 2%, so the asset purchases continue.

In the panic that followed Bernanke's comments, the yield on the 10-year Treasury hit a high of 2.66% after spending much of the last two years at 2% or less. The S&P 500 reacted with a 90-point, or 5.4%, decline over the course of three trading days.

On Monday, the equity market started to bounce back on the possibility it was overreacting to Bernanke's comments. The yield on the 10-year also started working its way lower on Monday and closed at less than 2.5% Thursday.

On the way down last week, the segments hardest hit were emerging markets and bond funds. Not surprisingly, these two segments did well on the way back up. Last Friday, as fear and the selloffs were accelerating, I noted the extent to which the market was moving more on emotion than anything else, but emotion doesn't just take prices down. In the last three days the S&P 500 is up 3.3%. A move of that magnitude is about the emotion of relief.

It is unlikely that we have seen the last taper scare for the year, and the one from last week may not even be over yet. If you can recognize a panic for what it is and know that there will be a snapback in short order, it should be easier for you to endure future panics.

There are multiple portfolio implications here as well. The Fed is buying assets in the open market every month and keeping interest rates near all-time lows as it tries to stimulate the economy. This will end at some point, and there will be a consequence for markets. This has been known since the Fed started its quantitative easing program, but last week shows us that even a hint of tapering will send markets lower.

In an article last week, I looked at shorter-duration corporate bond ETFs that available from Guggenheim and that allow investors to choose a targeted maturity date.

iShares offers a similar suite of municipal bond ETFs. PIMCO, iShares and SPDR all offer short-dated TIPS ETFs targeting 1-5 years, and these have worked too.

In the last month the iShares Barclays TIPS Bond Fund ( TIP), which has a weighted average maturity of 8.6 years, is down 6% compared to just a 2% drop for the PIMCO 1-5 Year US TIPS Index Fund ( STPZ).

The other step to take would be for anyone who has not already done so to devise an exit strategy for their longer-dated fixed-income holdings.

If the Fed is back to being more data-dependent then we may see rates go down a little over the course of the summer but probably not back to the lows.

That means the summer would be a good time to shorten your portfolio's average maturity because when the Fed really does end its asset purchases, bond prices are likely to go down much more than they have in the last month.

At the time of publication, Nusbaum held shares of STPZ. His firm also held STPZ on behalf of clients.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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