Shoppers walk through a retail area known as the "Magnificent Mile"… (Daniel Acker / Bloomberg )
NEW YORK -- The Federal Reserve has recently put the brakes on this year's stock rally with talk of weaning the U.S. economy off easy money.
But could the Fed's signals throw a wrench into the recovery?
Since the Fed telegraphed last week it may begin slowing its monetary stimulus later this year, stock and bond markets have been in a tizzy. Although stocks rebounded a bit Tuesday, the Dow Jones industrial average has dropped nearly 4% over the last five days. The benchmark 10-year Treasury bond's yield has spiked, and mortgage rates have jumped too.
If rates rise much higher, the turmoil could threaten the housing market's recovery, weighing on the value of families' most valuable assets. The stock market's correction could also make investors feel less wealthy when they open their brokerage or 401(k) statements.
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If the 10-year Treasury hits 3%, mortgage rates could inch higher to 5%, said Russ Koesterich, global chief investment strategist at BlackRock Inc. If the housing and stock markets take a significant hit, consumers may be less willing to spend, he said.
“This is going to undermine that 'wealth effect' that the Fed has been trying to create,” Koesterich said. “This is the danger: The market can react negatively in the short-term, but this stuff does feed back into the real economy."
Stocks rallied Tuesday, however, after a series of steep declines. The Dow rose 100.75 points, or 0.69%, to 14,760.31.
To be sure, the blue-chip index is still up nearly 13% for the year, despite recent setbacks.
Investors feasted on a stream of upbeat economic data. One was a read on consumer confidence, although it relied on research predating the stock-market pullback.
The Conference Board said Tuesday its consumer confidence index jumped to 81.4 this month, up sharply from 74.3 in May, its highest level since the Great Recession got underway in early 2008.
Despite the stock market's gains Tuesday, the yield on the 10-year Treasury note continued to climb. After closing around 2.55% Monday, the yield was inching closer to 2.6% Tuesday afternoon.
Koesterich expected Fed officials to soothe the bond market by telegraphing the central bank's intentions to continue purchases. Also, large institutional investors such as pension funds and insurance companies will probably step up bond purchases as rates rise, and that could help stabilize rates, Koesterich said.
Either way, he said, the Fed has a tough job ahead as it unwinds its epic stimulus program.
“There is no playbook for how to do this,” he said. “This is one of the reasons you’re seeing the market react this violently.”
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