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(Getty Images/iStockphoto)
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Stocks adjusting to taper talk, but not homebuilders Add to ...

The stock market is looking a lot more confident that the Federal Reserve’s “tapering” business will work out okay: The S&P 500 rose as high as 1645 on Monday, its highest level since mid-June, when the Fed announced that it could start to wind-down its bond-buying stimulus program, known as quantitative easing or QE, later this year if the economy continues to improve.

The broad index has rebounded more than 4 per cent from its recent low and is less than 2 per cent below its record-high close in mid-May. Stocks could be signalling that an improving economy trumps stimulus.

But everything isn’t necessarily great, given that U.S. mortgage rates have been climbing sharply in recent weeks, threatening the recovery in the housing market.

“Bear in mind that the interest rates that matter most for the economy are not the rates at which the government can borrow, but the rates facing private investors – and above all, mortgage rates, for housing is the most important transmission mechanism for monetary policy,” said Paul Krugman, the Princeton University economics professor on his New York Times blog.

He also reproduces a chart that originally appeared in the Financial Times, illustrating that for all the talk about tapering, the more dramatic shift is in market expectations for interest rate increases. The Fed has said that it won’t touch its key rate until the unemployment rate falls below 6.5 per cent, as long as inflation remains low. Markets had been anticipating the first rate hike in the second half of 2015.

Suddenly, though, markets now see a far greater chance of the first rate hike occurring a year earlier than that – in the second half of 2014.

From Krugman: “The Fed didn’t mean this to happen; it tried to communicate that it wasn’t changing the path of short-term rates; but this was naive on its part. The Fed can’t really commit to future policy; all it can do is signal its character, and what it ended up doing here was convey the sense that it’s much more inclined to tighten too soon than previously thought.”

But hey, the stock market appears to be okay with that, too. That said, there are interesting things happening beneath the surface here. For example, the S&P 500 homebuilding index is in a bear-market slump, falling 25 per cent from its mid-May high. It is now at its lowest level of the year.

On other hand, banks are doing just fine: The S&P 500 banks index has risen 6.9 per cent since the Fed delivered its “tapering” policy on June 19, putting it close to a five-year high.

  • S&P 500 INDEX
  • Updated April 29 4:40 PM EDT. Delayed by at least 15 minutes.

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