The Fed Just Shocked Investors: Here's What You Need to Know

This week should remove any doubt about whether markets are highly dependent on the Fed. They sure are. Indeed, you could not have constructed better conditions for a controlled experiment. Yet, ironically, the medium-term investment stakes are now higher.

There’s been no major economic news this week to speak of. On the corporate side, and with the exception of Microsoft’s dividend/buyback announcement, it’s also been relatively quiet.

Yet the Dow gained 300 points in the last three days (Monday-Wednesday). The S&P, a broader measure of the stock market, did even better in percentage terms.

Equally notable, the surge in equities was accompanied by a similar increase in bond prices. Gold also rose by over 2%. Even oil prices recovered, overcoming the dampening impact of a reduced probability of a military strike on Syria.

No matter how hard you look, there is only one major factor that can consistently explain this week’s market moves. And it centers on expectations of Fed policy.

On Sunday night, Larry Summers withdrew his name from consideration for Fed chair. This immediately restored Janet Yellen’s front-runner status to replace Ben Bernanke – a change that was quickly embraced by markets given that investors know a lot more about Ms. Yellen’s views on monetary policy. The resulting reduction in uncertainty was turbocharged by markets perceiving, rightly or wrongly, Ms. Yellen as potentially more dovish than Mr. Summers.

Earlier today, the Fed delivered an ultra-dovish policy message at the end of its two-day meeting – and, I stress, ultra-dovish.

The central bank surprised materially by maintaining “as-is” its support for markets. Indeed, most analysts and many market participants were expecting some “taper” in its monthly $85 billion of unconventional bond purchases.

The Fed also downplayed its previously-articulated concerns about the collateral damage of prolonged policy experimentation. And it added to the surprise by sounding dovish on already-specified policy conditionality.

The markets should be expected to celebrate; and they sure did, courtesy of the Fed.

Looking forward, it is only a matter of time until markets (and the Fed) will need to revisit a central issue – the extent to which fundamentals can be persistently disconnected from artificially-supported asset prices.

The hope is that a durable improvement in economic fundamentals – particularly brighter prospects for jobs and growth – will validate the high prices over time. The risk is that prices will converge down to fundamentals and, in the process, undermine the longer-term policy credibility of the Fed.

Pending this important medium-term clarification, markets are celebrating; and the Fed has proven that it still enjoys tremendous influence on asset prices regardless of fundamentals.

Photo: Medill DC/Flickr

Donald E. L. Johnson

Writes newsletter Stock Picking, Options Trading for Income

11 年

Everyone speculates about what the Fed will do next and how markets will react. Some guess correctly. Some don't.

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We are just living on steroids now and markets are getting dizzy with the high. Scary what the future holds. Remember the song by the Police . So Fed .... Every move you make Every bond you break Every step you take We'll be watching you.....

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mpumi malangabi, MBA

#Blockchain #AI #ML #LevFin Advisory

11 年

if i may jump in here: let us not forget there is a new force in the marketplace called # introduced by twitter. Hashtag has rested away power from government. The is now in the hands of the people. Hashtag has done for communication what #OIL did for the #AUTO. Mpumelelo Zulu

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