Has the Fed’s Plan Backfired?

Bernanke’s helicopter was meant to get markets flying high again – the rotor blades are spinning, but the uplift hasn’t happened.

(October 29, 2012) — The Federal Reserve’s efforts to shift investors out of safe assets may have backfired – last week saw the highest redemptions from United States equity funds in almost a year, while “risker” global bond funds boasted record inflows.

In the seven days to October 24, investors pulled more money out of US equity funds than they had in 49 weeks, according to data monitor EPFR. This flies in the face of the intention of the country’s central bank to get investors back into financial markets and – with improved risk appetites – bolster the US stock markets.

“Investors are taking on more risk,” said Cameron Brandt, global research director at EPFR. “But they are doing so largely within the fixed income universe and, when it comes to equities, bypassing the US in favour of emerging markets.”

Last week, the S&P 500, which tracks the largest stocks in the US, hit lows not seen since the start of the year, but rebounded by the close of trading on Friday.

“The benefits of QE3 continue to ebb for US equity funds, which look set to extend a yearly outflow streak that stretches back to 2004,” a note from EPFR said. 

The beneficiaries of the redemptions have mainly been fixed income funds, but those investing in US assets mainly did not receive inflows. Instead, European bond funds saw their best weekly inflow since EPFR began tracking movements in the first quarter of 2002 and funds investing in emerging market equities and bonds also saw strong numbers of new assets.

A study by asset manager Lombard Odier this month found that the third round of Quantitative Easing (QE) had failed to lift equity markets like its predecessors had managed.

Unlike the aversion seen towards the US, European equity funds have seen inflows in recent weeks, following the action of the European Central Bank to try and curb the problems with the Eurozone. These funds saw the best weekly inflows in over a month, EPFR said, while Japanese equity funds are on course for their best haul of new money since 2005.

Another knock-on effect to markets is the current elephant in the room. For many market participants the so-called fiscal cliff, which could hit the US economy by 4% and put it back into recession, is playing on their minds. Most politicians’ stance has been one of total avoidance so far, but it has to be tackled soon after the presidential election.

John Stopford, co-head of fixed income & currency at Investec Asset Management, said: “The big risk is that in the short term the politicians are not going to agree anything very soon. It is almost certain that they are going to wait until after the election and it might go quite ‘close to the wire’ in terms of either just before year-end or go beyond the wire and get addressed soon after.”

Stopford said the lack of confidence in the US financial markets, and economy overall, would last until at least the Christmas break.