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Investing Specialists

The Perfect Storm Sinks Stocks and Bonds

Economic news this week was plentiful but uninspiring, as shopping, housing, and earnings were nothing to get excited about.

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Collectively, it's hard to imagine a set of news that could do more damage to so many markets so strongly than this week's reports. The Fed appears to be losing its taste for quantitative easing, the economy is looking less robust than hoped, and now even the corporate news has turned negative. The 10-year Treasury surged to 2.86% and stocks fell sharply for most of the week, especially on Thursday, when the Dow fell more than 200 points.

The Fed's San Francisco District issued a paper this week that suggested QE2 added just over 0.1% to GDP growth, hardly the kind of return one would expect from a relatively risky policy. Some of the Fed governors must have been reading the paper as even the more dovish governors seem to be entertaining the possibility of reducing bond purchases as early as September. The recent soft economic data doesn't seem to have scared any of the governors who have been speaking recently. To be fair, the Fed claims to be primarily interested in just employment data and inflation. With initial unemployment claims hitting a recovery low and year-over-year inflation picking up again (both announced this week), one couldn't be blamed for thinking the end of bond purchases remains clearly in sight. About all that stands in the way of a September tapering program is the August employment report. My guess (I am stressing the word "guess" at this point) is that it might be bad enough to give the Fed pause. However, that just delays the Fed's inevitable withdrawal from the bond market and higher interest rates.

Robert Johnson, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.