Tags: Federal Reserve | stimulus | easing | money

Market Reaction Shows Hopes of More Dovish Fed Go Unfulfilled

Wednesday, 29 October 2014 03:54 PM

The knee-jerk reaction in markets to the Federal Reserve policy statement was clear: Hopes that this month’s volatility would inspire the central bank to take a more dovish stance were left unrequited.

The Standard & Poor’s 500 Index extended its loss to 0.7 percent at 2:16 p.m. and the Dow Jones Industrial Average declined as much as 89 points. Ten-year Treasury yields rose to their highs of the day at 2.36 percent and the dollar extended gains versus the euro, yen and other major peers.

The Fed said it sees further improvement in the labor market while confirming it will end an asset-purchase program that has added $1.66 trillion to its balance sheet.

“Labor market conditions improved somewhat further, with solid job gains and a lower unemployment rate,” the Federal Open Market Committee said today in a statement in Washington. “A range of labor market indicators suggests that underutilization of labor resources is gradually diminishing,” the panel said, modifying earlier language that referred to “significant underutilization” of labor resources.

Policy makers maintained a pledge to keep interest rates low for a “considerable time.”

The U.S. stock market had a full head of steam behind it coming into this meeting. The S&P 500 rebounded 6.6 percent from a six-month low on Oct. 15 through yesterday after retreating 7.4 percent from its record on Sept. 18.

Stocks rebounded as St. Louis Fed President James Bullard suggested on Oct. 16 that the Fed should consider delaying the end of its quantitative easing program. Bullard was credited with helping to “calm market jitters” as Barclays Plc asset-allocation strategist Sreekala Kochugovindan put it in a report today.

What exactly Bullard had to say is worth revisiting. He told Bloomberg’s Michael McKee that he still expected economic growth would be more than 3 percent next year, and the market turmoil that sent oil prices and interest rates lower were bullish factors “feeding into an already strong U.S. economy.” It was declines in expectations for inflation, he said, ’’that a central bank cannot abide.’’

“For that reason I think a reasonable response of the Fed in this situation would be to invoke the clause on the taper that said that the taper was data dependent,” he said. “If the economy is still as robust as I’m describing it, then I think we could just end the program in December, but if the market is right and it’s portending something more serious for the U.S. economy, then the committee would have an option of ramping up QE at that point.”

‘Hot Money’

The question is, was the market right about the economic outlook when he spoke?

As BlackRock Inc. Chief Executive Officer Larry Fink said at a charity event the following week, the tumble in the market was caused by “hot money” and hedge-fund borrowing. The drop “weeded out the excesses,” he said, and long-term investors should use it as a buying opportunity.

Stocks had hinted that maybe the selloff was over the day before Bullard spoke. The S&P 500 dipped as much as 3 percent on Oct. 15 to come within seven points of an intraday low of 1,814.36 set on April 11, before erasing most of that loss and ending the session with a drop of 0.8 percent. Still, the next day it appeared as if lower lows could be on the table again. The S&P 500 dipped as much as 1.5 percent before Bullard spoke, then ended the session little changed.

So was the market actually right to think that the economic outlook was worsening, then wrong to think that Bullard was signaling the Fed’s punch bowl still had a few cups left in it? Or is it just as confused as the rest of us?

“There are concerns that we have now entered an environment in which financial markets are more vulnerable to bouts of panic, as seen over the past month,” Barclays’ Kochugovindan wrote today.

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The knee-jerk reaction in markets to the Federal Reserve policy statement was clear: Hopes that this month's volatility would inspire the central bank to take a more dovish stance were left unrequited.
Federal Reserve, stimulus, easing, money
Wednesday, 29 October 2014 03:54 PM
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