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As uncertainty grows, investors shy away from risk

Traders work on the floor of the New York Stock Exchange


We are now just one month away from the end of the U.S. Federal Reserve's massive stimulus program and investors are edgy about what will follow.

The uncertainty isn't causing panic, partly because the Fed has managed to engineer a pretty good recovery with its two rounds of quantitative easing. But as the June 30 deadline approaches, investors are reducing risk and waiting for signs of what to expect.

The Fed gave some indication this month about how the current $600-billion (U.S.) quantitative easing program, or QE2, will wind down. It also left the door open for a third round if the economic recovery falters.

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Brian Clouse, managing director of institutional equity trading at Wellington West Capital Markets Inc., doesn't think Fed officials can just walk away from their stimulus efforts.

"They've gone this far with it. There's no way they are just going to let the market take over and hope for the best," he says.

"They have to manage the process beyond the conclusion of QE2. They may mask it and turn it into a different program. But the fact remains, they will continue to try to keep rates low, and they will do that until they see some support in the overall economy. And I don't think we're there yet."

This scenario would be good news for the markets, but investors are in limbo as they await details. Money is moving out of riskier assets such as resource stocks and into perceived havens, including U.S. government bonds. Increased demand for 10-year Treasury bills pushed prices up for the second week and drove yields down 8 basis points to 3.07 per cent last week.

Over the last three months, Canada's resource-heavy S&P/TSX index has dipped 1.5 per cent while the broader-based S&P 500, loaded with big-name defensive stocks, has edged up 1 per cent.

While macro economic issues will remain challenging, corporate fundamentals remain in good shape and today's trepidation could set the stage for a nice market rally in the fall, once there's more clarity on further stimulus efforts, Mr. Clouse says.

Some economists are looking at a similar timeline for improved economic growth. Recent data have looked soft, as high gasoline prices have crimped consumer spending, supply disruptions in Japan have rippled through the automotive industry and bad weather has affected the energy sector. Growth in the current quarter will slow by 50 per cent or more compared with the first quarter, economists forecast.

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Canadian GDP figures are expected to show a robust 4-per-cent expansion in the first three months of the year, up from 3.3 per cent at the end of 2010. Economists say the increase will come from business purchases, rather than consumer spending. But the consensus is that later this year, oil prices will decline and inflation worries in China and other emerging markets will cool.

The bumpy road to recovery has changed market expectations regarding tighter monetary policy in both the U.S. and Canada, with investors now assuming that interest rate hikes will be delayed.

The Bank of Canada will announce its latest interest rate policy on Tuesday. Despite calls from the Organization for Economic Co-operation and Development for Canada to begin tightening monetary policy, economists don't expects a hike in the overnight rate. But they will be parsing Governor Mark Carney's words for an indication of whether rates will begin to rise again this summer, or possibly get delayed until late this year in the face of weak economic data.

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